In this morning’s scheduled rate announcement from the Bank of Canada, they confirmed that they will be maintaining their overnight rate. This is the rate that mortgage lenders use to set their prime rate.
While their rate remains unchanged as expected, they announced that they are not just winding down their quantitative easing program, they are flat out ending it. This may lead to the Bank of Canada increasing their rate sooner than originally expected. They had been holding to their prediction that this wouldn’t happen until the second half of 2022, however it’s now possible they could increase their rate sooner than that.
How much sooner?
They are now predicting for the first increase to come in the middle quarters of 2022. This could be anywhere from April to September. It’s highly unlikely they will move earlier than this. I still think it will come later rather than sooner, but time will tell.
Eight Rate Increases By The End Of 2023?
Last week, there were news headlines stating that the Bank of Canada could increase their rate by as much as eight times by the end of 2023. This was a pretty bold prediction, and was the opinion of a single analyst. To this date, I have not seen a one other analyst in agreement. It does however catch people’s attention, which was likely their intended goal. It definitely worked.
Yes, the prime rate will be increasing. That we all know
But eight rate increases by the end of 2023 is not a realistic expectation.
The question is how many rate increases can we expect, when will we see the first one, and how fast will the increases come?
Rate Increases Will Also Lead To Future Rate Drops
If the Bank of Canada moves their rate up aggressively, then that also increases the chances that they will need to drop it as well. It’s unrealistic to think that rates will continue to increase over the next five years with no decreases along the way. What often happens is the BOC may increase a few times, followed by a drop.
Will they drop back down to where they are today?
While I don’t have a crystal ball, I think a resounding NO is a pretty safe prediction.
Remember, it took COVID’s impact on the economy to bring rates down to where they are today.
As it finally looks as though we’re coming out of this pandemic, mortgage rates will also come up from their pandemic driven lows. Some people are telling me that they think 2.14% sounds like a high rate. Of course it does when you compare it with the lowest pandemic rates. But prior to summer of 2020, 2.14% was the lowest 5 year fixed rate offered in history. It’s still an amazing rate. Just not as low as what we’ve seen over the 16 months or so.
Does this mean that everyone should now be taking a fixed rate?
Absolutely not, however a bit more thought may need to go into your decision.
A Few Things To Consider When Choosing Fixed Or Variable
Variable rate mortgages have come out over fixed rates more than 80% of the time over the last 40 plus years. Those are pretty good odds, but that doesn’t mean that things can’t change. There have been many rate increases over the past 40 years, and many decreases as well. The prime rate will rise, and then it will fall. It moves in both directions, and that’s something that we need to understand when considering a variable rate mortgage.
If the thought of a few rate increases will cause you to lose sleep, then I recommend taking a fixed rate. The increases are coming, so you need to be prepared for it.
If you’re planning on taking a variable rate, but plan on locking into a fixed as soon as rates increase, then you’ll be much better off going with a fixed rate from the get go. Part of having a variable rate mortgage is riding the ups and downs along the way.
If you’re still not sure, then you’ll want to check out my blog on The Ultimate Guide To Choosing Fixed Vs. Variable
A Big Advantage To Variable Rates
Another advantage to variable rate mortgages is the penalty is most often just three months interest. For anyone who has inquired about breaking a fixed rate mortgage over the last 18 months, you’ll know that fixed rate mortgage penalties can be severe. The only way to guarantee yourself a specific penalty is to choose a variable rate.
A Comparison Between Fixed and Variable
Let’s now take a look at how rate increases will affect the cost of a variable rate mortgage when compared with fixed.
We’ll use a $500,000 mortgage amortized over 25 years, and will compare a variable rate at 1.00% (prime -1.45%) with a 5 year fixed rate of 1.99%*.
Example 1 – Nine rate increases with first increase after six months
If the rate were to increase after six months and then again every six months until the end of your term for a total of nine increases, it would look like this:
Time of Increase % Rate Change Rate After Increase
6 months +0.25% 1.25%
1 year +0.25% 1.50%
1 year 6 months +0.25% 1.75%
2 years +0.25% 2.00%
2 years 6 months +0.25% 2.25%
3 years +0.25% 2.50%
3 years 6 months +0.25% 2.75%
4 years +0.25% 3.00%
4 years 6 months +0.25% 3.25%
Should this happen, choosing variable would have cost you an additional $1,849.81 over the fixed rate option. Yes, the fixed rate would be the winner here, but it’s not as though you’ll be out tens of thousands. Considering the rate has more than tripled to 3.25%, you’re out by less than $2,000. That’s IF there are nine increases and IF there are no decreases along the way. Note your ideal situation, but not disastrous either.
Example two – Nine increases with the first increase after nine months
If the Bank of Canada were to hold off on their first increase for another three months, and continue increasing every six months afterwards (still nine increases), then the scenario plays out a bit differently:
Time of Increase % Rate Change Rate After Increase
9 months +0.25% 1.25%
1 year 3 months +0.25% 1.50%
1 year 9 months +0.25% 1.75%
2 years 3 months +0.25% 2.00%
2 years 9 months +0.25% 2.25%
3 years 3 months +0.25% 2.50%
3 years 9 months +0.25% 2.75%
4 years 3 months +0.25% 3.00%
4 years 9 months +0.25% 3.25%
The same number of increases, and the same ending rate of 3.25%, yet in this scenario
you would come out ahead with the variable rate by roughly $840. You’re not exactly lighting up the stage with savings, but you’re still ahead by choosing variable. Again, this is with nine consecutive increases without any decreases along the way, which is unlikely.
Example three – Ten rate increases with two decreases
As I continue to mention, it’s not realistic for rates to continue to increase without any decreases along the way, so let’s look at one more example throwing in a couple of decreases into the mix. We’ll even add in one additional rate increase along the way for a total of ten. This would be 12 rate movements over the next five years:
Time of Increase % Rate Change Rate After Increase
9 months +0.25% 1.25%
1 year 3 months +0.25% 1.50%
1 year 9 months +0.25% 1.75%
2 years 3 months +0.25% 2.00%
2 years 9 months -0.25% 1.75%
3 years 3 months +0.25% 2.00%
3 years 6 months +0.25% 2.25%
3 years 9 months +0.25% 2.50%
4 years +0.25% 2.75%
4 years 3 months -0.25% 2.50%
4 years 6 months +0.25% 2.75%
4 years 9 months +0.25% 3.00%
This is now a total of ten rate increases over the next five years, but we’ve tossed in a couple of drops along the way as well, which is a realistic expectation. Should this situation play out with the above timeline, you’d save roughly $4,180 over the term by choosing the variable rate.
Not bad at all.
…and that’s with 10 rate increases!
Why It Doesn’t Matter If Your Variable Rate Moves Higher Than Fixed
Even though the variable rate has surpassed the original fixed rate offered by a longshot, you’ll still come out ahead. As your variable rate was lower for the more than half of your term, you’re so far ahead by this point that the additional interest just starts to eat into your savings.
You still win with variable, despite the ending variable rate being that much higher than the original fixed offered.
Conclusion
No one can say for sure what will happen and all we can do is speculate based on the information we have available to us today.
The choice between fixed and variable will always be a personal decision. Just because your best friend, your brother, sister, parents, uncle, etc, has chosen a variable rate, it does not mean that you should too. What’s right for them might not be right for you. Everyone is a bit different in their own way, and this includes having different tolerances for risk.
The best choice is not always the one that saves you the most money. It’s the one that allows you to sleep soundly at night.
If you’re nervous about where rates might be heading over the next five years, then a fixed rate might be your best choice, regardless of what ends up happening. There is a lot to be said for peace of mind.
You can read the full announcement from the Bank of Canada here.
*Note that mortgage rates can vary depending on a number of factors in including purchase price, down payment / equity percentage, purchase date, transaction type, etc. Reach out to us directly to find out the lowest rate available for your situation!
