Photo Courtesy of Bank of Canada
Fixed Rates On The Rise. Variable Rates Will Probably Rise By April 2022
On Wednesday of last week, the Bank of Canada (BoC) held its key interest rate at 0.25 percent, where it's been since March 2020. But experts warn that interest rates will soon climb as the economy is now recovering from the Covid-19 pandemic.
The BoC overnight lending rate directly affects variable rates, so if the overnight rate has increased, so will all variable rate products like mortgages and line of credit products.
Fixed mortgage rates work a little differently.
Unlike variable rates, fixed mortgage rates correspond to bond yields, which are defined as a loan agreement entered into by an investor and a bond issuer.
The BoC buys bonds to manipulate short-term interest rates, especially during major economic disruptions like a pandemic. When the federal government buys bonds in an open market, this acts as a way to increase the money supply in the economy because bonds get exchanged for cash. When the central bank buys government bonds, it raises their price and lowers their returns (the interest paid back to bondholders). This also gets reflected on five-year fixed-rate mortgages, making it cheaper to borrow money to buy a house or refinance a mortgage, for example.
Unfortunately, when the fed purchases bond yields, it fuels inflation (higher home prices and costs for goods and services). Eventually, this must get counterbalanced with the easing of bond purchases (known as ending quantitative easing QE). During the pandemic, the BoC purchased $5 billion worth of government bonds, which has led to exceptional mortgage interest rates. However, now that the economy is recovering from the pandemic, BoC will being to ease its buying of bond yields, which means fixed mortgage rates will rise and likely a lot faster than we have seen before.
Consider fixed rates have already increased by approximately 30-50 basis points in the past month. Although this slight rate hike has not stopped bidding wars, continuous increases in fixed mortgage rates will probably start a cooling effect, which will lead to a real estate market correction.
Since July 2021, 51 percent of mortgage borrowers have chosen variable rate mortgage products because of the record low discounts, which are anywhere from 75 to 95 basis points off the prime rate (2.45%). Because variable rates are almost 1 percent cheaper than fixed rates, they currently are a more favourable mortgage option.
What To Consider When Mulling Over A Variable Rate Mortgage
Some borrowers wonder whether variable interest rates may leave them vulnerable to rate increases. This can be true since variable rates depend on the Bank of Canada's overnight lending rate that could change (increase or decrease) throughout the year.
Keep in mind; variable-rate mortgages can also stay the same if the overnight lending rate does not change (which has been the case since March 2020). Nevertheless, fluctuations in variable rates can mean a borrower's monthly mortgage payment may increase or decrease without notice, which doesn't appeal to everyone. Statistically, variable rates are cheaper than fixed rates despite the fluctuations in interest rates considering the last 30 years of variable/fixed rate comparisons.
The general rule of thumb when choosing between a variable and a fixed-rate mortgage is whether you can afford a 2 percent increase in the interest rate. If the answer is yes, a variable rate is likely the better option.
Suppose you're currently in a fixed-rate mortgage and have a much higher rate or are concerned about rising rates shortly. Here, you can also consider breaking your existing mortgage and switching to a variable mortgage to experience more savings.
Here are some advantages of choosing a variable rate mortgage:
Do you want to book a one-on-one consultation to discuss your mortgage options?
By: Sarah Colucci
Senior Mortgage Agent, Lic. M14000929