Today marks a rare moment for many variable-rate borrowers because the Bank of Canada hasn’t raised its overnight rate in more than seven years, which means there are many among this group who have never experienced a rate rise (this is the part where the older generations shake their heads). Well, after years of ultra-low Prime rates…it seems today is the day that we’ll see an increase in bank prime, likely ¼%.
Our history says that variable-rate borrowers who convert tend to pay more over time than if they had stayed the course. While past is not necessarily prologue, in his famous fifty-year study that compared fixed and variable mortgage rates, Dr. Moshe Milevsky found that variable-rate borrowers who convert mid-term typically paid more than variable-rate borrowers who stuck it out. In other words, converting your variable rate today will give you peace of mind, but history says that you will probably be locking in additional cost over the long run.
Should You Lock in Your Variable Rate?
Is it time to panic and lock in? While your variable rate may be headed higher soon, I don’t think the rise will be dramatic, as many now suddenly fear. So, my answer is yes, and no, it depends on you. In my humble opinion, the media speculation has blown the rate increases out of proportion. When the media uses scare tactics, some people are bound to react out of emotion instead of logic and make a choice they would not normally make. Perspective is key! 10 years ago, the 5-year fixed rate was 4.99%. Even if we were to have two successive ¼% increases, most variable rate clients will still be well below 3%.
The Bank of Canada increased its key interest rate today by a quarter point, .25% which is an increase in monthly payment of $12.39 on the $100,000.00. When we take a closer look at how a rate increase affects you financially, it removes the fear, brings understanding and the ability to make an informed decision about your mortgage.
Here’s the math:
Mortgage Amount: $100,000.00 – 25 year amortization
Current Payment: $435.76 at Prime (2.70%) – 0.50 = 2.20%
New Payment: $448.15 at Prime (2.95%) – 0.50 = 2.45% (Bank of Canada Increase of .25%)
A difference of $12.39 on the $100,000.00 – 25 year amortization
If you have a mortgage of $300,000, you will see an increase of 3 x $12.39 = $37.17 a month or $18.58 bi-weekly
Currently, I am taking my own advice and staying the course. There are many reasons to maintain the use of a variable rate mortgage as outlined below:
- The interest rate calculation
- More of your payment goes to principal, especially in the first 2 years.
- The penalty is only 3 months simple interest.
- The ability to switchover to the fixed rate market anytime with no penalty or cost. Remember, once you switch to fixed you cannot return to variable until renewal or pay a penalty.
- A whopping 78% of first-time homebuyers will terminate or move their mortgage before the end of their 5 year term. Flexibility is key.
The bottom line is simple.
If you are feeling panicked (risk averse) that your payment may increase, this may signal that it is time for you to lock in. The last thing I want is you up at night worrying about your mortgage! If your cash flow is good and you are only mildly curious about next steps (risk tolerant), then I feel there is still a lot of mileage in a floating rate product.