With the Bank of Canada expected to announce another outrageous rate hike next week, a growing number of variable rate mortgage holders are asking themselves a dreaded question: is it time to lock in a fixed rate?
The answer usually comes down to the state of homeowners’ household finances, said James Laird, co-CEO of online rate comparisons side Ratehub.ca and president of mortgage brokerage CanWise Financial.
Borrowers who are the least bit worried about their ability to absorb further mortgage rate hikes should “seriously consider” moving to a fixed rate, he said. For those who still have a lot of wiggle room in their budget, it’s a matter of choosing the option that they think will ultimately save them money, Laird added.
If interest rates were to fall in late 2023 and 2024, assuming inflationary pressures ease amid a now widely expected recession, sticking with a variable mortgage rate might still be “the right strategy” , did he declare.
Calculator: Compare the impact of different interest rates on the cost of your mortgage
For now, however, anyone with a fluctuating rate should be prepared for more pain. The Bank of Canada has already raised its key rate to 3.25%, from 0.25% at the beginning of March. And as it continues to fight inflation, the central bank is expected to announce another half-percentage-point hike on Oct. 26, with further hikes likely in December and early 2023.
According to some projections, the Bank of Canada rate will climb to 4.5% next year.
When the central bank’s policy rate changes, banks typically adjust their own prime rates, the benchmarks to which variable rates are pegged. For every quarter percentage point increase in the Bank of Canada rate, a homeowner with a variable mortgage rate and fluctuating payments can expect to pay about $14 more per month for every $100,000 pending, according to Victor Tran, a mortgage and real estate expert at Ratesdotca, a financial product comparison site.
For recent homebuyers whose principal balances have not fallen significantly and Canadians with large mortgages, the pain of these rapid rate increases has been particularly acute.
For example, a homeowner with a mortgage balance of around $380,000 — roughly the average borrowed by first-time home buyers over the past two years — would have seen their monthly payments increase by more than $600 since March. . If the Bank of Canada’s rate rose to 4.5%, this borrower would end up with a payment about $900 more than they had committed to.
And while the vast majority of variable rate holders have loans that would normally maintain payments even if interest rates rise moderately, this feature no longer guarantees peace of mind in current market conditions.
The recent series of interest rate hikes means that variable rate mortgages are starting to reach their so-called “trigger rate” – the rate at which the monthly payment no longer covers the interest due. Borrowers nearing their trigger are generally likely to receive larger payments unless they are able to make lump sum payments on their principal.
But moving to a fixed mortgage rate comes at a high cost in an environment of record mortgage rates.
Variable rate holders who typically lock in won’t have access to their lender’s most competitive rates, which are reserved for new customers, Tran warned.
Borrowers will also have to pledge for a period equal to or greater than what is left over the term of their mortgage, he added. In other words, a homeowner with a five-year variable and three years remaining before renewal should take out a fixed-rate mortgage for at least three years.
Those who prefer to commit to a shorter term in case rates start falling before too long will have to break their mortgage and pay a penalty. The fee is generally equal to three months interest applied to the remaining principal balance.
Switching to a competing lender offering lower fixed rates also means breaking your mortgage.
But an even bigger hurdle to finding deals on fixed rate mortgages for many of today’s variable rate mortgage holders comes from the need to requalify for the mortgage stress test. For those switching lenders, the test requires federally regulated lenders to verify that a new borrower would be able to meet their payments at the greater of 5.25% or two percentage points above the contract rate offered.
With current five-year fixed rates often above 5%, borrowers hoping to lock in could easily face an allowable stress test rate above 7%, a high bar for many homeowners to cross, Ms. Laird.
Mr Tran said the majority of his variable rate customers, who are mostly high net worth customers with stable incomes, are staying put for now.
Still, anyone wondering if they should lock themselves in should seek professional advice, said Frances Hinojosa, mortgage broker and co-founder and CEO of Tribe Financial Group.
“If you’re asking this question, it’s time to have a conversation with a mortgage professional to review your options.”
If you have a variable mortgage rate with fixed payments, you can estimate your own trigger rate using the calculator below.
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