Variable Rate Mortgages
Not Necessarily the Right Choice in a Rising Rate Environment
Interest rates are rising, and we are hearing a lot of mortgage brokers, advisors and commenters stating unequivocally that Canadian mortgage borrowers should prefer a variable rate mortgage over a fixed rate mortgage. However, if you took a fixed rate mortgage in 2021 you might have a rate of less than 2% today, which is better than current variable rates.
Today a mortgage with a fixed rate of less than 2% sounds fantastic. It appears that steering customers to variable rates in 2021 might have been unwise. Why then, after rates have started to increase and the Bank of Canada has said more rate increases are coming, are so many doubling-down on this advice so strenuously?
Your House is Not Like Your Other Assets
Yes, our homes are a significant investment but, for most, they come with much more emotional involvement than any of our other investments. Your home is your shelter, a place to raise a family, an anchor for you in your community and a refuge from the busy world. We can love a house in a manner far more personal than we can a stock, bond, or crypto asset.
Is your home simply a way for you to make money, or will it be a much more meaningful investment? Some may be fine with including an element of interest rate risk into their homebuying decision. For others, safety and predictability are important considerations. There is no one-size-fits-all solution. Any discussion with a borrower about fixed versus variable rate mortgages must take into account the borrower’s personal preferences and needs.
Is a Variable Rate Mortgage Always Best?
The notion that a variable rate mortgage is preferable solely because variable rates are lower than fixed rates is an analysis that distills the idea of home ownership down to a purely financial decision. Such a bias towards variable rate mortgages does not necessarily serve borrowers well. What about peace of mind? What about not needing to worry about the direction of interest rates? What about simplifying your budget? What if you don’t want to take a punt on interest rates, especially on the financing for the family home?
Although a lower rate is desirable, pushing clients to always favor a variable rate is based on a simplistic analysis. While it is true that in recent history a borrower with a variable rate probably saved money relative to a borrower with a fixed rate, interest rates have been in a downtrend for the past 40 years. Of course, this is the outcome in that environment. It is important to remember that variable rates can change in both directions.
Can Anyone Predict Future Interest Rates?
The five-year Canada bond had a yield of 0.80% in Sept 2021. Today it is at 2.87%. The Bank of Canada raised their short-term interest rate by 50 basis points last week and are expected to do so again in June. Now the Governor of the Bank of Canada has suggested that the June rate hike could be greater than 50 bps. Some market participants want to act as if they know what will happen to interest rates over the next few years. Yet none of them predicted either of the outcomes just noted. Predicting future interest rates is a fool’s game.
Don’t listen to advice from your mortgage advisor that is based on their predictions of where interest rates may go. Rather than automatically directing you to a variable mortgage rate, your advisor should assist you in assessing your unique situation and determining your own preferences and needs when it comes to rate selection.
Is Fixed or Variable Right for You?
The choice of a fixed rate vs variable rate mortgage is a personal one. It primarily depends on your risk tolerance. Are you willing to take the chance that variable rates will rise, possibly significantly, costing you money in the form of higher monthly mortgage payments? Are you, on the other hand, willing to lock in a fixed rate mortgage today, knowing that if rates fall, you will not benefit during the term of the mortgage?
Trying to predict the future is difficult. We submit that it is also not wise to position your home for gain or loss on your best guess for the future direction of interest rates. In part because it is an economic prediction about the future that most of us are not paid nor trained to understand. Your mortgage broker or sales advisor at a bank are paid for providing mortgage expertise to help with your borrowing decisions and are not paid macro-economic advisors that should be opining on the direction of interest rates. The argument that variable rates are better than fixed rates because they are lower today assumes that the person giving this advice has a crystal ball that can predict future interest rates. This is reckless and listening to mortgage advisors who profess to know these things is not sound. How then, does a Canadian borrower make an evaluation of fixed versus variable rates in these unpredictable times?
How to Decide on a Fixed or Variable Mortgage Rate
Rather than making blanket statements that mortgage borrowers should take out a variable rate mortgage, every individual’s situation should be evaluated. What works for one borrower may or may not work for another. Variable rate mortgages and fixed rate mortgages both have advantages and disadvantages.
Please click this link to see a prior blog we wrote that summarizes the pertinent factors that go into making a choice between a fixed or variable rate mortgage.
Fixed Vs. Variable Rate Mortgages (frankmortgage.com)
Bear in mind as you read it that the most important factors are your own level of risk tolerance and your budget.
Mortgage Stress Test Complications
The Government-mandated stress test now makes it harder to qualify for a fixed rate mortgage than a variable rate mortgage. With a stress test requiring borrower qualification at the higher of i) 5.25% or ii) the mortgage rate plus 2.0%, and fixed mortgage rates now above 3.25%, a fixed rate mortgage now has a higher qualifying rate than a variable rate mortgage.
Perhaps you can now only qualify for a variable rate mortgage. If that is the case, then it is your only alternative. However, note the risks of a variable rate mortgage and plan your finances accordingly.
Conclusion
Variable rate mortgages have been popular lately, comprising close to 50% of mortgage originations. Perhaps becoming accustomed to a low interest rate environment has made many forget how volatile interest rates can be. But fixed rate mortgages have long been the most popular way to finance a home. They make budgeting easier and help borrowers avoid unwelcome surprises when interest rates fluctuate.
Make sure your mortgage broker fairly evaluates the pros and cons of both variable rate and fixed rate mortgages. This is your decision to make. Do what gives you peace of mind. Home ownership is much more than a financial investment.
If you would like to speak with a licensed mortgage agent about choosing a fixed or a variable rate mortgage, please go to www.frankmortgage.com or call us at 1-888-850-1337.
Don Scott
Don Scott is the founder of a challenger mortgage brokerage that is focused on improving access to mortgages. We can eliminate traditional biases and market restrictions through the use of technology to deliver a mortgage experience focused on the customer. Frankly, getting a mortgage doesn't have to be stressful.
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