Should you lock in a variable rate mortgage?

Canadians with variable rate mortgages would be wise to keep an eye on announcements from the Bank of Canada (BoC) regarding its prime rate.

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At the beginning of 2022, for example, high inflation prompted economic experts to expect prime borrowing rates to increase considerably.

The BoC dropped the prime rate to 2.45% at the start of the COVID-19 pandemic (from its previous recent high of 3.95% since the end of 2018). However, significant rate hikes were forecast for the rest of 2022 and into 2023. 

Large jumps in Canada’s prime rate can have a serious impact on mortgage payments for anyone who holds a variable mortgage. Variable mortgage rates tend to rise and fall along with the BoC’s prime rate.

Variable-rate to fixed-rate mortgage: what you could save

Let’s say your variable mortgage rate was at 2%, then by the end of the year it rose to 3% after BoC prime rate increases. Here is how that could impact various mortgage payments (assuming a 20-year amortization):

 

Loan amount

Monthly mortgage payment at 2%

Monthly mortgage payment at 3%

$200,000

$1,010.98

$1,107.33

$400,000

$2,021.96

$2,214.67

$600,000

$3,032.94

$3,322.00

 

A variable rate increase of one percentage point can mean thousands more dollars in mortgage payments over the course of a year. This could put considerable pressure on your cash flow, regardless of the level of your household income.

How — and when — to decide to switch

Whenever interest rates look likely to start climbing, some homeowners are likely to begin wondering whether they should lock into a fixed rate mortgage or continue to stay on the variable rate ride.

This decision often boils down to an individual’s appetite for risk. Some people feel more comfortable knowing that their interest rate (and therefore their mortgage payments) will remain the same. It certainly makes budgeting a lot easier.

Switching, though, isn’t quite that clear-cut. In some cases, going from a variable rate to a fixed rate mortgage could require you to break your current mortgage, which can come with a prepayment penalty of three months in mortgage interest. Some companies, however, including IG Wealth Management, will waive this charge for clients who want to convert their variable mortgage to a fixed rate of equal or longer term.

For lenders that charge a penalty to convert from a variable to a fixed rate mortgage, the amount of time you have left on your mortgage term may determine whether converting it is worth the cost. The closer you get to your term’s maturity date, the lower your costs are likely to be. However, should rates continue to rise, locking into a fixed rate sooner may save you more on interest costs in the long run.  

There is something else to consider: how much and how frequently rates are expected to rise. While variable rates could move higher than current fixed rates over time, in the short term the fixed rate is likely to be pricier than your variable rate, so you’d need to plan for the additional costs. 

To help you decide if a fixed or variable rate mortgage is better for you, read our article, Understanding fixed and variable mortgages.

Mortgages are about way more than just rates

There are options available other than just straightforward variable and fixed rate mortgages. It’s possible to set up a variable rate mortgage with a fixed payment. When rates rise, you pay more in interest than principal and vice-versa if rates fall. The benefit is that, from a budgeting perspective, the amount you have to pay remains the same.

When it comes to mortgages, working with a mortgage professional can help you map out the implications of each option in the context of your long-term goals.

Mortgage specialists can also help homeowners to find other solutions tailored to their needs, such as having longer amortizations, shorter mortgage terms or higher frequency payments. There are also hybrid mortgages (where a portion of the mortgage can be set up as a variable rate and some as a fixed rate), as well as home equity lines of credit (HELOC).

Before you take that leap, get professional advice

You have plenty more options than you probably realize: your IG Consultant can connect you with an IG Mortgage Planning Specialist who can help you pick the best one to suit your needs, or you can contact one here.

 

Written and published by IG Wealth Management as a general source of information only. Not intended as a solicitation to buy or sell specific investments, or to provide tax, legal or investment advice. Seek advice on your specific circumstances from an IG Wealth Management Consultant.

Banking products and services are distributed through Solutions Banking™. Solutions Banking products and services are provided by National Bank of Canada. 

™ Solutions Banking is a trademark of Power Financial Corporation. IG Wealth Management and design are trademarks owned by IGM Financial Inc. and licensed to its subsidiary corporations. National Bank of Canada is a licensed user of these trademarks. 

Mortgages are offered through I.G. Investment Management, Ltd.* Inquiries will be referred to a Mortgage Planning Specialist (in Ontario, a Mortgage Agent, and in Quebec, New Brunswick and Nova Scotia, a Mortgage Broker). 

*In ON and NS, registered as a Mortgage Brokerage (ON 10809, NS 3000240) and a Mortgage Administrator (ON 11256, NS 3000232), in QC, registered as a financial services firm (QC 2400376104) and in NB, registered as a Mortgage Brokerage.