Interest rates are rising. Is it time to switch to a fixed rate mortgage?
The Bank of Canada raised its benchmark interest rate to 0.5 per cent on Wednesday
This column is by Mark Ting, a partner with Foundation Wealth who helps clients reach their financial goals. He can be heard every Thursday at 4:50 p.m. on CBC radio as On the Coast's guide to personal finance.
For the first time since 2018, the Bank of Canada has hiked the overnight interest rate to curb inflation and cool the real-estate market. With increasing interest rates many variable mortgage holders are considering switching to a fixed rate mortgage.
With the 0.25 per cent overnight rate hike, I am now paying 1.65 per cent for my variable mortgage. Assuming the Bank of Canada follows through with its plan to hike rates five more times over the next 12 months, my rate would still be under three per cent, which is lower than the current offer on a fixed rate mortgage.
Interest rates in the bond market, which are used to price fixed term mortgages, have been moving upwards for almost a year. Six months ago, it was easy to get a five-year fixed term mortgage for under two per cent compared to the current rate of approximately 3.3 per cent.
While my variable mortgage allows me to transition to a fixed rate version at no cost, I'm not considering this for the following reasons:
- The time to have locked into a fixed rate was months ago when rates were much lower. Fixed rates are well above their lows, whereas variable rates have just started to increase. The current spread between variable and fixed rate is significant and a variable mortgagee could absorb an additional six or seven more rate hikes of a quarter per cent before reaching the current fixed rate level of 3.3 per cent.
- I'm skeptical that the Bank of Canada will follow through with its plan to hike rates five more times by this time next year.
- History has shown that central banks usually fall short of their rate hike goals. Variable rates offer more flexibility and lower penalties than fixed rate mortgages. Many borrowers end up breaking their term if they need to re-finance or sell.
The penalty for breaking a variable mortgage is typically three months of interest whereas a more punitive calculation is usually used with a fixed rate.
The main reason for switching to a fixed rate is if you experience anxiety every time the Bank of Canada makes an interest rate announcement. For a five-year fixed rate, 3.3 per cent is still historically low and below current levels of inflation, so if you prefer the peace of mind — the fixed option makes sense.
It's a sellers' market with signs of buyer exhaustion
The current rate hike comes at a time when the real estate market is showing signs of slowing. Over the past couple of months, buyers with expiring mortgage pre-approvals increased demand and homes sales by front running the rate increase. For now, it is still a "sellers'" market, but we are seeing signs of buyer exhaustion.
The stock market correction and higher inflation are variables that will act as real estate headwinds. People do not feel as "wealthy" as they used to and have become hesitant to make large purchases or act as the "bank of mom and dad."
In terms of tailwinds, real estate is seen as a hedge against inflation, while immigration is expected to bring thousands of people to Metro Vancouver at time when supply is still low and the cost to build has never been higher.
While I don't expect a major crash, it wouldn't surprise me if we have a quieter than usual spring real estate market with fewer sales and moderate pricing.