Fixed or variable? How to pick a mortgage as interest rates rise

The Bank of Canada’s effort to cool the housing market by hiking interest rates has house hunters and home owners alike re-examining what kind of mortgage they can take on.

Global News spoke to mortgage experts and economists to help break down the factors consumers should be considering as they crunch the numbers on monthly housing payments in the midst of a rising interest rate environment.

How are mortgage rates determined?

First things first, know the different kinds of mortgages available to you.

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A fixed-rate mortgage offers homebuyers a steady interest rate for a set term, usually set in three-to-five year increments over the length of the mortgage.

These rates aren’t immediately affected by the Bank of Canada’s interest rate moves — even if expected hikes can be baked into the rate you’re offered — and therefore provide a bit more predictability in your monthly payments through the length of the term.

A variable-rate mortgage changes in response to Bank of Canada interest rate decisions, as financial institutions tie their prime rates to central bank’s benchmark rate. You’d then get a discount on top of that.

For example, today’s variable-rate mortgage contract might offer you the prime rate of 3.2 per cent minus 0.6 per cent, according to Leah Zlatkin, mortgage broker and expert with lowestrates.ca.

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Variable rates are “typically” lower than their fixed-rate counterparts, Zlatkin says.

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To figure how these two rate-types could affect monthly payment strategies, the key factor is the “spread” between them.

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Today, Zlatkin pegs the typical variable-rate mortgage between 2.3 per cent and 2.6 per cent, while fixed-rates come in at around 3.89 per cent. The spread, then, is around 1.6 per cent.

That spread will tend to contract as the Bank of Canada raises interest rates. The prime rates offered by banks will rise, closing the gap between today’s fixed-rate sums and variable-rates payments down the road.

Bank of Canada Governor Tiff Macklem has made no secret that the institution will be “forceful” with rate hikes in an effort to tamp down on surging inflation.

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The central bank took a rare 50-basis point step last month to raise its key overnight rate to 1.0 per cent. Some economists are anticipating another half a percentage point hike when next rate announcement comes in June.

“Everybody’s got an opinion on where they think rates are going and nobody quite knows unless you’re in the Bank of Canada, in which case you’re probably not telling anyone,” Zlatkin says.

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Desjardins said in a mortgage rate forecast last week that it expects the central bank to “rapidly raise the key rate” in the year to come but it will be kept below 2.5 per cent.

The Bank of Canada said last month that it believes the “neutral rate” — the point at which interest rates are neither fuelling or hampering the country’s economic growth — is between 2.0 per cent and 3.0 per cent.

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If the central bank raises rates that high in the current cycle, variable rates would rise by 100-200 basis points and mortgage holders with this type of loan would immediately set monthly payments to reflect the higher rates.

Is now the time to lock in a fixed-rate mortgage?

Jimmy Jean, chief economist at Desjardins, tells Global News that the Bank of Canada’s plans to rapidly raise interest rates could end the popularity of variable-rate mortgages following years rock-bottom rates influenced by the pandemic economy.

“We’ve seen a lot of take up for variable-rate mortgages. But the more we go (there), the more that spread is going to narrow. … It might make sense in this context to lock in (the) interest rates that we can get now,” he says.

Sung Lee, mortgage agent with RATESDOTCA, tells Global News that in the short-term there’s still a “compelling reason” to go with a variable mortgage today even with more rate hikes on the horizon. He points to the roughly 150-basis-point spread between most variable offers and the current fixed rate.

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Though she cautions that she doesn’t have a “crystal ball,” Zlatkin expects an increase of 0.75 per cent total in the central bank’s overnight rate before the end of 2022. For that reason, she says variable rates will remain the cheaper option in the long-term. But she notes that the bottom line isn’t the biggest priority for more risk-averse market watchers.

“If you’re the kind of person that’s going to be watching those Bank of Canada announcements every single time having a heart attack, it’s not worth it,” she says. “Just pay a couple of hundred dollars extra and go with a fixed rate.”

Why you might not qualify for as much mortgage

There’s another factor to consider with interest rates on the rise, and it might affect how much house you can afford.

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The mortgage stress test has prospective buyers — as well as those looking to refinance an existing mortgage — qualify for the loan at the higher of two rates: either the rate on offer plus two per cent or the qualifying rate of 5.25 per cent.

While those seeking pre-approval for a mortgage in the past few years might have become accustomed to qualifying at the 5.25 per cent bar, today’s rising rate environment could mean taking on mortgages of 3.5 per cent or higher.

With the added two per cent, those buyers are now looking at qualifying for mortgages at 5.5 per cent or higher. Zlatkin says a couple that might have qualified for a $500,000 mortgage three months ago, might only be able to secure something around $473,000 today.

“Therefore, your budget for the new home needs to change as well,” she says.

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Just because your buying power isn’t stretching as far in today’s market doesn’t mean it’s a bad time to buy, however.

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Rising interest rates are already having a cooling effect on Canada’s housing market, Jean says, with sales starting to “moderate” in most markets and prices in provinces such as Ontario and Quebec potentially having peaked.

Lee adds that with rates on the rise for the foreseeable future, there’s little chance your mortgage will stretch much further in the coming months.

“I don’t think rates are going to go down any further in the short-term,” he says. “So if you can get into something now that fits within your budget, I think it’s a great plan.”

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