Interest rates have risen considerably – we all know this. None of us knows where they go from here, but what should you do with your mortgage, especially if it is coming up for renewal? Most experts are recommending the five-year variable-rate mortgage or the 2- or 3-year fixed rate mortgage.
To start the decision-making process, let’s look at what current rates are (these are uninsured mortgage rates and apply to those who require a refinance)
1-year fixed: 7.24 per cent
2-year fixed: 6.84 per cent
3-year fixed: 6.44 per cent
4-year fixed: 6.24 per cent
5-year fixed: 6.09 per cent
5-year variable: 6.95 per cent (prime minus 0.25)
Home equity line of credit: 7.2% (prime) plus .25% = 7.45% or plus .50% = 7.7%
Fixed vs. Variable
Over the years, variable-rate mortgages have generally provided a better return than fixed-rate mortgages. Since 2000, variable-rate mortgages have resulted in lower interest costs upwards of 90% of the time. This makes sense since you are paying a premium for knowing exactly what your rate will be for a specified period — peace of mind.
In the minority of times that a fixed-rate mortgage has been better, it’s been during a period prior to rising rates. As we know, a fixed-rate mortgage that was locked in around 2020 at 2% for five years is a pretty great place to be in today’s world. On the flip side, in a period prior to falling rates, a variable-rate mortgage is likely going to be the best option.
Just like any financial choice, part of the decision is based on your personality and risk appetite. If you know you want certainty and do not want to take risks, then a fixed rate mortgage is very likely the best option for you regardless of where we are in the interest rate cycle. The ability to budget around a set payment for a certain period can go a long way to securing your overall comfort.
2 or 3-year Fixed Rate Mortgage
Based on the bond market and yield curve, the market is telling us that it expects interest rates to come down over the next couple of years. Looking at the current inflation numbers, employment trends and overall growth, the picture is one that should give the Bank of Canada reason to pause interest rate hikes, and one that should induce rate declines in 2024 to 2026. Given this view, I don’t recommend my clients lock into a five-year fixed mortgage at 6.09%. This rate will likely be much lower in two to three years. For a three-year $500,000 mortgage at 6.44% with a 25-year amortization period, the monthly payment would be $3,331. While the 3-year mortgage rate is higher, that 3-year term will take you into your next renewal date with lower rates.
HELOC or 5-Year Variable
The reasons to look at moving a mortgage to a HELOC are that you don’t want to lock anything in at today’s rates while maintaining flexibility. The other reason for the HELOC might be lower overall expenses in a time of higher mortgage payments. Any way to increase cash flow could be of interest.
Let’s look at the same $500,000 example using a HELOC at prime, 7.2% plus .25% or in most cases plus .50%. This translates into a monthly cost of roughly $3100 to $3200. While you wouldn’t be paying down any principal, that may not be the number one concern at a time of elevated inflation and tighter budgets. If interest rates fall, the HELOC payments will fall with them, and we may then see greater discounts on five-year variable-rate mortgages.
A couple of years ago, not only was the prime rate much lower, but many of these mortgages were as low as prime minus 1.1%. Today, a good rate is prime minus 0.25%. In a 5-year variable rate mortgage, that same $500,000 would require a payment of $3487
If you are risk averse or think interest rates will keep rising, then lock into a shorter-term fixed rate. However, if you are willing to take on a bit of risk and think interest rates will fall, try to remain as flexible and exposed to variable rates for as long as possible and opt for a HELOC or a variable rate mortgage.
A transfer is a great way to go if you do not require any additional money and you can keep the current amortization. Many financial institutions will transfer your mortgage as is and most times the rates and fees are more favorable.
Always remember, penalties can make or break your savings in any of the above scenarios. A HELCO is an open line of credit, so there is no penalty. The variable rate mortgage is almost always 3 months interest penalty, and the fixed rate mortgage is the greater of the interest rate differential and 3 months interest. The interest rate differential is based on the time left in your current term and the going rates. This type of penalty can be 4 times higher than the 3-month interest penalty.
Why Use a Mortgage Broker
There are so many mortgage purchasing options available to consumers. Careful analysis and a good understanding of the risks and your specific requirements is key to making the right decisions. This is why a Mortgage Broker who specializes in this process is a good choice, in ensuring your interests are best served. When you go directly to a bank or finance company, unfortunately, they have their employer’s best interest in mind. As a mortgage specialist I check in with my clients every 6 months to ensure their mortgage/HELCO still makes the most sense for them. I also provide rate insurance. Rate insurance ensures clients have the lowest rate and best possible mortgage for their situation. If there is a better mortgage or rate, I can do the analysis to determine if a change is in your best interest.
If your mortgage is coming up for renewal, or you just want to know if you’re in the right one, feel free to get in touch with me. I would be happy to answer any questions you have.