It’s hard to believe it’s the middle of December and 2023 is right around the corner. For those shopping for a home or in a variable rate mortgage, the New Year can’t come soon enough. On December 7th, 2022, we experienced the last Prime Rate increase of the year. Many economists believe that this may be the last one for a while and are hoping for a more stable market going forward. In addition to that, some are predicting interest rates may start to decrease by the last quarter of 2023 and/or early 2024.
Inflation & Rate Hikes
Not only did Canadians have to deal with the highest inflation rates we have seen in over 40 years, but they also experienced some of the highest Prime Rate increases since April 2001 when Prime was at 6.50%.
With all these rate hikes, many are left wondering if they should convert their variable-rate mortgages to a fixed rate. Let’s go over the pros & cons of locking in.
Why you might want to lock in
This year we have seen Prime increase 7 times totalling a 4% increase since January 2022. With that said, I don’t blame you for considering locking in! Let’s break down the type of variable-rate mortgages before we get started.
Adjustable Variable-Rate Mortgages
Your payment increases and decreases with Prime Rate adjustments. The only thing guaranteed for your term (ex. 5-year term) is the discount off of Prime Rate, ex. Prime - 1.00%. As of today, if we use this example, your rate would be Prime (6.45%) - 1.00% = 5.45%. With this type of mortgage, your lender typically notifies you of any Prime Rate changes and adjusts your mortgage payment automatically on your behalf.
Static Variable-Rate Mortgages
This is when you are at a variable rate, but your payment stays the same. How does this work? Because your payment does not adjust automatically, the interest within your payment will increase or decrease as Prime changes. Since we have been in a rising rate environment, more interest is being paid to the lender with each Prime Rate increase and less principal is being paid off for your home. Instead of your payment increasing, the lender adjusts your amortization (the period of which you have to repay your total loan, ex. 25 years stretched out to 35 years). However, they can only do that for so long before your whole payment turns into interest and you are no longer paying the principal off. At this point, the lender contacts you and gives you three options: switch to a fixed rate, make a lump sum payment or increase your payments to bring your amortization back in line.
Either option can be worrisome because your payments have either been increasing for the majority of 2022 or now you have been contacted by your bank to adjust your payments significantly. These increases have resulted in a payment difference of hundreds of dollars per month since you first got your mortgage and now you’re considering a fixed rate.
What would it look like if you locked in now?
You may have a couple of options if you’re thinking about locking into a fixed rate, such as staying with your existing lender or switching lenders to find a better rate/mortgage product.
Your lender will provide you with a quote for current fixed rates, but as an example, I’ll use 5.29% for an insurable mortgage. While this may seem like a no-brainer, if you remember my example above of Prime - 1.0% = 5.45% and now fixed rates are similar or lower. While this rarely happens, it’s important to remember the pros and cons of a fixed-rate mortgage.
Pros and Cons of Fixed Rate Mortgages
The obvious benefit of a fixed-rate mortgage is that the payment stays the same for the duration of your term (ex. 5 years). This means no more up and down with Prime Rate changes. That said, you must consider your short and long-term plans when committing to a fixed rate and a new term with your lender. Fixed-rate mortgages tend to have higher penalties in a declining rate environment. So if rates start to drop in the future, as some economists predict will happen by the end of 2023 or early 2024, you may be stuck in your new fixed-rate mortgage because the penalty is too high to break. When rates dropped significantly during the pandemic, many homeowners faced penalties upward of $20,000! So if you think that there is a chance that you may break your new fixed-rate mortgage term, you may want to consider staying in a variable-rate mortgage (which is only a 3-month simple interest penalty).
Now that you understand the pros and cons of a variable-rate mortgage, the decision is ultimately yours!
Ask yourselves these few questions:
Are you comfortable staying at your fixed rate for the full term, even if rates drop in the future? If so, consider a fixed rate.
Do you need to know exactly what your payment is every month so that you can budget and keep up with your cost of living? If so, consider a fixed rate.
Are you losing sleep at night worrying about your mortgage payment? If so, consider a fixed rate.
Do you plan to move, upsize or downsize, during your new term (ex. 5 years)? If so, consider staying variable.
Will you need to access equity within your term, consolidate debts, do a renovation or make a large purchase? If so, consider staying variable.
Will you need to add or remove someone from your mortgage within your term? If so, consider staying variable.
An advantage of using me as your mortgage broker is that I am here to help you understand your options so that you can make an informed decision. If you still have questions or want to run some payment comparisons before you make any commitments. I look forward to having a discussion with you about your goals and your risk tolerance.