For those feeling the squeeze on their budgets due to the Bank of Canada's seven interest rate increases since March 2022, switching to a fixed-rate mortgage may be a consideration. However, before taking the leap, it's crucial to weigh the pros and cons of all available options.
There are two types of variable-rate mortgages: fixed payment and adjustable rate mortgages. With a fixed payment variable-rate mortgage, monthly payments remain the same each month.
As rates increase, more of the payment goes toward interest instead of the principal, which extends the amortization schedule, or the time it takes to pay off the property.
When the interest payments exceed the total payments, you hit the trigger rate, which leads to the lender making margin calls.
Adjustable rate mortgages are more complicated, with rates that fluctuate depending on the prime rate. Homeowners are not likely to feel the effects of interest rate increases right away, but they will be reflected in the semi-annual mortgage payments. When the prime rate changes, so does the payment.
Many people opted for variable-rate mortgages in the past decade as they believed it would save them money. The idea was that they could tolerate changes over the mortgage's term.
But the situation has now changed, and those who went with variable rates are paying more than the fixed rates initially offered. Although staying with a variable rate may be beneficial if you need to break your mortgage before the term is up, you might need to lock in with a fixed rate if monthly payments are causing you to lose sleep.
Lock in low long-term mortgage rates
Jova Xu, a realtor in Vancouver with Jovi Realty, suggests that breaking a fixed-rate mortgage involves penalties of three months' interest or the interest rate differential, whichever is higher.
When you break a variable-rate mortgage you often incur a penalty of three months' interest. A fixed-rate mortgage may not be advisable if there is a chance of selling the house before the mortgage term is up. Furthermore, during a declining interest rate environment, it may not make sense to lock into a five-year fixed rate and risk getting charged a penalty in the future when rates are lower.
While interest rate increases might seem like a lot in the short term, it is not a game-changer over a 25-year mortgage amortization or your lifetime. A 1% higher or lower mortgage rate on a $500,000 mortgage balance is only $5,000 per year. Therefore, it is essential to consider one's individual situation and weigh the pros and cons of locking in a fixed mortgage rate.
Are interest rates going up in Canada?
The Bank of Canada has decided to hold its key rate unchanged at 4.5%, after eight consecutive increases. The bank's decision to pause was justified by the continuous decline in year-over-year inflation since it peaked at 8.1% in June of last year.
Despite the economy's resilience and tight labour markets, many economists and financiers predict that the policy rate will remain unchanged in the upcoming announcement. However, the failure of many banks around the world has raised financial stability concerns above price stability worries. Therefore, I predict that interest rates are going to go up.
The bank's pause made it the first major central bank to halt interest rate hikes, putting it on a different trajectory relative to the United States. This could fuel inflation by raising the price of most imported goods.
Although year-over-year inflation was 6.3% in December, the data shows that prices increased very rapidly until June, particularly in the food, shelter, and gasoline sectors, which were responsible for 75% of the price hike. In particular, gasoline prices increased by 48% and accounted for 40% of the overall inflation in the first half of 2022.
The tight labour market is what worries the Bank of Canada the most. The unemployment rate remained close to its historical low at 5% in January, and wages rose 5.4% compared to their levels a year ago. A tight labour market is a symptom of an overheated economy, and the bank's credibility is at stake.
The Bank of Canada's decision on April 12 to hold its key rate unchanged was expected, but I believe that the bank might raise the policy rate next month. With an overheated economy, rising inflation, and a tight labour market, the bank's credibility is at stake, and a rate hike may be necessary to maintain price stability and financial stability.
So people should seriously consider locking in their mortgages.
Alistair Vigier is the CEO of ClearwayLaw, a website that allows the public to leave reviews for every real estate lawyer in Canada and the UK.