Weighing the options— variable or fixed rate mortgages?

On July 13, the Bank of Canada announced an increase of its policy interest rate by a full 1%.

Prime rate is now at 4.7%. This is the largest single increase since 1998 and has many variable mortgage clients questioning their decisions and trying to figure out what to do with their mortgages.

Variable rate mortgages historically outperform fixed rate mortgages over the long haul. It’s easy to say this and feel confident when rates are low but when rates start to trend up then what?

Clients choose variable rate mortgages for different reasons. One of the key reasons I discuss with my clients is the potential penalty if they have to break (pay in full) their mortgage earlier than the scheduled renewal date.

If you are in a variable rate mortgage, your penalty will be three months’ interest regardless of when you break your mortgage. In a fixed rate mortgage, you could be potentially looking at thousands of dollars in penalties. For me this is an important consideration.

Most clients tell me this is a “forever” home and they have no intention of changing their mortgage over their term. But life can throw curve balls.

Some of the reasons that people may need to break their mortgage early include:

• Marriage or relationship ending

• Need to refinance

• Work transfer to a different location (with no need of a mortgage or your current lender isn’t the right fit)

• Windfall such as an inheritance or a settlement

If you are in a variable mortgage right now and are panicking about what rates are doing and how this affects your bottom line, let’s go back and look at the math.

For every $100,000 of mortgage balance you are carrying, an increase in prime of 0.25 per cent increases your payment by approximately $20.82. Even with this increase, over time you will most likely come out ahead, based on historical trends.

When I work with clients making their decisions about fixed versus variable rates, I run the math for them to show the difference in potential interest costs for one over the other. Some clients are most concerned about stability and certainty, and for them that is the right decision.

I mentioned in a previous column that I talk to clients about the difference in payments between the options of fixed or variable and if they decide to go variable, I recommend still putting away the higher payment every month in case rates do go up.

My own mortgage is variable so I’ve had a few moments the last few weeks where I’ve thought long and hard about the best move for me. I keep coming back to the reason I chose variable in the first place and am staying the course.

I don’t have a crystal ball but I do follow several economists. Several have commented we are in for a bumpy few months as the government tries to curb inflation, but we will see interest rates starting to trend back down towards the end of the year or in early 2023.

If you are home shopping and have been working with a broker or banker who pre-qualified you to purchase at a certain price point, it is critical you touch base with them prior to writing an offer to see how this last increase affects your price point.

Up until July 13, we were able to use the Bank of Canada Benchmark rate to determine your mortgage amount if you were choosing a variable rate. With this latest increase in the prime rate, we are now having to use the contract rate plus two per cent. So, in most cases, this will affect the maximum mortgage you qualify for.

The bottom line is if you are concerned about your rate, reach out to your mortgage person.

This article is written by or on behalf of an outsourced columnist and does not necessarily reflect the views of Castanet.