Canadian mortgage rates have been on a wild ride of late

It started in late February when five-year fixed rates were offered at about 2.75% and five year variable rates were tendered in the 2.90% range. Most borrowers were opting for the stability of a fixed rate against that environment, which had been in place for some time.

Then the Covid 19 crisis hit, and the Bank of Canada (BoC) slashed its policy rate by 0.50% three times in March, dropping it from 1.75% all the way down to 0.25%.

Variable mortgage rates initially fell in response, but then as the severity of the crisis became more obvious, they started moving up instead of down. Here is a brief explanation of how and why that happened:

• Variable mortgage rates are priced on lender prime rates, which typically move in unison with the BoC’s policy rate.

• When the BoC’s policy rate dropped, lenders followed suit and dropped their prime rates, but they also decreased the discounts off prime that they were offering to variable-rate borrowers.

• Lender prime rates dropped from 3.95% in late February to 2.45% by mid-April, but over that same period five-year variable rates only climbed from prime minus 1.00% (2.95%) in late February to prime (2.45%) by mid-April.

• In other words, the BoC’s policy rate dropped by 1.50%, but five-year variable mortgage rates only fell by about 0.50%.

• The elimination of the variable-rate discount was caused by COVID-related risk premiums that had been added by both financial markets and lenders.

(Reminder: variable-rate mortgages can be converted to fixed rates at any time, and the penalty to break them is only three months’ interest.)

Today, four months later, five-year fixed and variable rates are offered in the high 1%/low 2% range. Now that rates have moved lower, let’s take a renewed look at the fixed vs. variable question, and to do that, let’s start with a summary of the current situation:

• Mortgage rates have fallen to record lows.

• The BoC is now engaged in easing (aka money printing).

• Government debt is blowing up. That backdrop has led most to speculate that higher inflation is coming and that fixed-rate mortgages are the better bet.

Thanks to historically low spreads between the two, that choice is becoming easier for many.

“If you’re in the trenches shopping for a new mortgage, I’m going to tell you something I’ve rarely told anyone in 13 years in this business: Variable rates are a gamble that you don’t need to take,” RateSpy founder Rob McLister wrote recently in the Globe and Mail.

“There’s little question in my mind that you’ll win for at least a year or two by floating your mortgage rate. But year three is a crapshoot. And years four and five entail legitimate risk of higher borrowing costs.”

“However today, with only 20 bps or less of price difference, variables lose their luster.”

As of today, some of the most competitive mortgage providers are offering 5-year fixed rates at less than 10 basis points above the lowest variable rates.

Variable Rates Have Little Room Left to Fall

When prime rate plunged from 3.95% to 2.45% in March at the height of the pandemic, it lowered mortgage rates for thousands of variable-rate holders. Some are now enjoying floating rates as low as 1.50%.

But for new borrowers, variable rates have largely lost their appeal since prime rate has very little room left to fall, if at all.

And it’s increasingly looking like prime rate is as low as it will go.

Bank of Canada Governor Tiff Macklem has previously put the kibosh on the idea of negative interest rates, and has said, “When you look at the current situation… I’m quite comfortable with the effective lower bound where it is.”

Apart From a severe resurgence of COVID-19 or faltering of the current economic recovery, interest rates are likely staying put for the immediate future—and that could be a year or longer.

Most brokers agree that fixed rates at these levels are hard to pass up given the stability they offer.

While there currently isn’t much risk of being in a variable rate for the time being, he notes that if inflation begins to grow, you will want to jump into a fixed rate, pronto. there are many factors to consider when choosing the right mortgage product.

For example, a variable-rate mortgage can make more sense if the homeowner is likely to payout the mortgage early and they want a predictable three-month interest penalty. A fixed-rate mortgage, although at a slightly higher rate, can provide peace of mind for people who just want to know their payments won’t change.

For those still tempted by variable rates that are still slightly lower than comparable fixed rates, here’s one more factor to consider: Fixed rates are now so low that even a single quarter-point rate hike from the Bank of Canada—three to four years from now— could result in borrowers paying more interest in a variable than a 5-year fixed

Contact the Ottawa Mortgage Shop we would be happy to discuss this further with you.