Fixed vs. Variable Mortgages in Times of Rising Interest Rates – The Mortgage Gal

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Last weekend I attended the Mortgage Professionals Conference in Vancouver. My goal was to attend as many professional development sessions as possible because I find that we are operating in a very strange interest rate environment.

Ironically, and I never thought I’d say this, the session I enjoyed the most (and arguably the most enjoyed) was Benjamin Tal’s presentation. Tal is Managing Director and Deputy Chief Economist at CIBC Capital Markets Inc.

He shared his thoughts on our current rate environment, the driving forces behind the Bank of Canada’s economic policies, and where he thinks rates are headed.

He also talked about the unprecedented rate hikes we’ve seen this year. The Bank of Canada is desperately trying to rein in inflation and he thinks the bank has gone too far and overstepped its bounds with rate hikes this year.

I am a fan of variable rate mortgages. One of the main factors influencing this is the cost of terminating your mortgage early. If you have to pay your mortgage in full and it doesn’t make sense (or doesn’t work) to transfer your current mortgage, the maximum penalty you will be charged is three months interest.

With a fixed rate mortgage, the penalty for breaking your mortgage is normally the greater of the Interest Rate Differential (IRD) or three months interest. Investopedia.ca shows how an IRD penalty is calculated:

“An IRD assesses the interest rate contrast between two similar interest-bearing assets. Most often, it is the difference between two interest rates.

This type of sanction can be substantial. I am currently working with a client who is selling a luxury property whose current mortgage is up for renewal. This is a large mortgage and it’s understandable that he’s worried about the volatility of mortgage interest rates right now.

I did the math for him. If he had taken out a five-year fixed rate mortgage, based on the current rate situation and his mortgage balance, his penalty would have been in the range of $32,000. The variable rate penalty, again based on today’s balance and rate, would be approximately $6,000. So for this particular client who is absolutely going to sell his house next year, the potential increase in payment due to rising rates was a much more palatable option than a $32,000 penalty.

All that aside, for many Canadians who have variable rate mortgages, the incredible rate hikes we’ve seen this year are putting a massive dent in their monthly budget. It’s really tempting to think about locking yourself into a fixed rate product for payment stability.

One consideration is how you will feel if you lock in a rate in the mid to high 5% range when rates start falling again. Do you sleep better at night knowing you have the security of a fixed payment? Are you losing sleep thinking about changing rates?

I recommend you think about why you chose the variable in the first place. You probably enjoyed very low rates during the first part of your term and you will most likely enjoy lower rates towards the end of your term as rates begin to drop again.

I guess I should have started with that. According to Tal, we expect another big rate hike very soon, but he thinks rates will stabilize next year and start falling again late next year or early 2024.

One option is to split the difference. There are lenders that offer true variable mortgages with a static payment. This means that no matter where the rates move, your payment stays the same. I would have to say it stays the same until the rate increase means you are not paying enough to cover the interest due, which will affect your amortization.

You would have to pay a three month interest penalty to terminate your current mortgage to switch to a lender that offers a static payment. Most lenders will allow you to capitalize up to $3,000 of your penalty into your new mortgage (more if you do a refinance instead of a direct switch, provided you have enough equity to make it work ).

By going this route, you’ll still enjoy the benefits of an adjustable rate mortgage once rates start to drop again, without worrying about potential penalties if you have to pay off your mortgage unexpectedly.

If you’d like to discuss this and see if it’s right for you, I’d be happy to do a mortgage checkup and give you some insight.

This article is written by or on behalf of an outsourced columnist and does not necessarily reflect the views of Castanet.