Are You Looking For A Variable-Rate Mortgage? Here’s Why It May Not Be Good For You

You are here:

If you’re shopping for a new mortgage, you may read around a lot of scepticism concerning the variable-rate. Are they an unnecessary gamble?

On the plus side, you may win for at least a year or two by taking the chances; but after that, it’s finger-nail biting time. Years 4 and 5 could prove very challenging for your finances.

Why all the negativity?

Let’s start with the obvious that hasn’t left anybody this year… The Bank of Canada has used that period to swamp our financial market with liquidity. And it’s promised to keep doing that well into next year by buying an array of debt securities, which temporarily suppresses mortgage rates and inspires people to borrow.

In addition, you’ve got the Finance Department trying to put smiles back on again by handing out billions of dollars to workers affected by COVID-19.

Many fear all this spending will catch up with us when the economy recovers by driving inflation higher. And even if an inflation spike lasts only a year or two, that may be all that’s needed to help five-year fixed rates outperform.

With the lowest fixed rates now less than seven basis points above the cheapest variable rates a single rate increase by Bank of Canada in the next 42 months would make a floating rate more expensive based on interest cost alone. (There are 100 basis points in a percentage point.)

How likely are we to see a hike by the central bank in that time frame? The experts chime in.

“The short answer is that it is very likely that the Bank of Canada will raise rates at least once in the coming 3.5 years,” Benjamin Tal, deputy chief economist at Canadian Imperial Bank of Commerce, said in an interview. “We have to remember that we are at emergency rates and a reasonable scenario is that the emergency will not last for 3.5 years given the nature [of it].”

Unprecedented stimulus and record-high government debt issuance simply aren’t compatible with 0% interest rates in the long term. When our government stops buying bonds, unemployment subsides and consumer demand eclipses pre-crisis levels, the ceiling on rates goes away.

And when it happens, it happens quickly. Yields can surge by 75 basis points or more seemingly overnight – well, in 30 to 60 days – once traders think inflation is headed back above the central bank’s 2% target.

When that occurs, you’ll want to be in a fixed rate. It’s logical!

‘Timing is everything’

For Joe Homeowner, flat to falling yields are good news from a borrowing cost perspective.

Given central bank buying and the uncertain near-term growth outlook, bond yields could easily drop further, taking fixed mortgage rates down with them. The problem is, no one knows for sure if, when or how far they’ll drop.

For those trying to time when to lock in, about the best we can say right now is that fixed rates will stay near or below current levels until the five-year bond yield exceeds 0.6% and stays there. It’s at 0.33% right now.

Until then, it’s a waiting game. And with today’s record-low sub-1.99% five-year fixed rates staring you in the face, you’ve got to ask yourself: How long are you willing to roll the dice and wait to save an additional one-, two- or three-10ths of a percentage point?

Playing it safe

If you’re applying for a new mortgage now, have a long-term financing need and an average-to-low risk tolerance, a five-year fixed below 2% has your name all over it. The risk-reward is easily “good enough.”

Of course, with central banks pledging to pin rates near zero for 1 to 2 more years, it’s tempting to take a chance on a one-year fixed. They’re priced at 1.59% to 1.99% depending on your home equity.

For financially solid borrowers, a short-term fixed is an understandable play – particularly with economists like Mr. Tal expecting minimal near-term rate risk. “I don’t see the Bank of Canada moving before 2022,” he projects.

But for a typical borrower who plans to keep a mortgage for five full years, today’s best value is a set-and-forget five-year fixed – from a fair-penalty lender in case you break it early – at 1.99% or less.