Fixed or variable? How to pick a mortgage as interest rates rise

The Bank of Canada’s effort to cool the housing market by hiking interest rates has house hunters and home owners alike re-examining what kind of mortgage they can take on.

Global News spoke with economists and mortgage experts to discuss the factors that consumers should consider when calculating monthly housing payments in the face of rising interest rates.

First, learn about the various types of mortgages that are available to you.

Fixed-rate mortgages offer homebuyers a fixed interest rate for a specified term. These are usually calculated in increments of three to five years over the life of the mortgage.

These rates aren’t immediately affected by the Bank of Canada’s interest rate moves — even if expected hikes can be baked into the rate you’re offered — and therefore provide a bit more predictability in your monthly payments through the length of the term.

A variable-rate mortgage changes in response to Bank of Canada interest rate decisions, as financial institutions tie their prime rates to central bank’s benchmark rate. You’d then get a discount on top of that.

For example, today’s variable-rate mortgage contract might offer you the prime rate of 3.2 per cent minus 0.6 per cent, according to Leah Zlatkin, mortgage broker and expert with lowestrates.ca.

Variable rates are “typically” lower than their fixed-rate counterparts, Zlatkin says.

To figure how these two rate-types could affect monthly payment strategies, the key factor is the “spread” between them.

Zlatkin currently rates the typical variable rate mortgage at between 2.3% and 2.6%, while fixed-rates are around 3.89%. The spread is then approximately 1.6%.

This spread will contract as the Bank of Canada increases its interest rates. The prime rates offered by banks will rise, closing the gap between today’s fixed-rate sums and variable-rates payments down the road.

Bank of Canada Governor Tiff Macklem has made no secret that the institution will be “forceful” with rate hikes in an effort to tamp down on surging inflation.

Last month, the central bank made a rare 50-basis points point move to increase its overnight rate to 1.0 percent. Some economists anticipate another half-point hike in rate when the next announcement is made in June.

“Everybody’s got an opinion on where they think rates are going and nobody quite knows unless you’re in the Bank of Canada, in which case you’re probably not telling anyone,” Zlatkin says.

Desjardins said in a mortgage rate forecast last week that it expects the central bank to “rapidly raise the key rate” in the year to come but it will be kept below 2.5 per cent.

The Bank of Canada said last month that it believes the “neutral rate” — the point at which interest rates are neither fuelling or hampering the country’s economic growth — is between 2.0 per cent and 3.0 per cent.

Variable rates will rise by 100 to 200 basis points if the central bank raises them in this cycle. Mortgage holders who have this type of loan would set their monthly payments immediately to reflect the higher rates.

Jimmy Jean, chief economist at Desjardins, tells Global News that the Bank of Canada’s plans to rapidly raise interest rates could end the popularity of variable-rate mortgages following years rock-bottom rates influenced by the pandemic economy.

“We’ve seen a lot of take up for variable-rate mortgages. But the wider the spread, the less we will be able to get. … It might make sense in this context to lock in (the) interest rates that we can get now,” he says.

Sung Lee, mortgage agent with RATESDOTCA, tells Global News that in the short-term there’s still a “compelling reason” to go with a variable mortgage today even with more rate hikes on the horizon. He points out the approximately 150-basis point spread between variable rates and the current fixed rate.

Though she cautions that she doesn’t have a “crystal ball,” Zlatkin expects an increase of 0.75 per cent total in the central bank’s overnight rate before the end of 2022. Variable rates will be the better option over the long-term, according to Zlatkin. But she notes that the bottom line isn’t the biggest priority for more risk-averse market watchers.

“If you’re the kind of person that’s going to be watching those Bank of Canada announcements every single time having a heart attack, it’s not worth it,” she says. “Just pay a couple of hundred dollars extra and go with a fixed rate.”

There’s another factor to consider with interest rates on the rise, and it might affect how much house you can afford.

The mortgage stress test has prospective buyers — as well as those looking to refinance an existing mortgage — qualify for the loan at the higher of two rates: either the rate on offer plus two per cent or the qualifying rate of 5.25 per cent.

While those seeking pre-approval for a mortgage in the past few years might have become accustomed to qualifying at the 5.25 per cent bar, today’s rising rate environment could mean taking on mortgages of 3.5 per cent or higher.

Buyers are now looking to qualify for mortgages at 5.5 percent or higher by adding two percent. Zlatkin states that a couple might have qualified for $500,000 three months ago but might be able now to secure $473,000.

“Therefore, your budget for the new home needs to change as well,” she says.

Just because your buying power isn’t stretching as far in today’s market doesn’t mean it’s a bad time to buy, however.

Rising interest rates are already having a cooling effect on Canada’s housing market, Jean says, with sales starting to “moderate” in most markets and prices in provinces such as Ontario and Quebec potentially having peaked.

Lee adds that with rates on the rise for the foreseeable future, there’s little chance your mortgage will stretch much further in the coming months.

“I don’t think rates are going to go down any further in the short-term,” he says. “So if you can get into something now that fits within your budget, I think it’s a great plan.”