Do I Lock In?

By Matt Olinski

In July, the Bank of Canada raised its key interest rate by one percentage point, the largest one-time hike since 1998, followed by another 0.75 percent on September 7th.

In this global climate – amidst the COVID-19 pandemic, the war in Ukraine, and unending supply chain disruptions – it’s no surprise that policymakers have aggressively increased rates to combat inflation. Rising rates make choosing the right mortgage crucial, and in a climate of climbing interest rates and inflation, many are left wondering, Do I lock in? To parse through this rapidly evolving topic, I sat down with Angie Alvarez, a mortgage expert specializing in a broad lending spectrum.

Matt: Over the last several months, we’ve seen dramatic rate increases. What’s causing this spike?

Angie: During the pandemic, the Bank of Canada cut interest rates. In 2020, some lenders offered a five-year fixed rate of 1.49 percent, the lowest in Canadian history. These rates were unsustainable long-term, so they’ve risen again.

M: And is this panic justified? How are your clients handling these rapid changes?

A: The shift was a shock at first. Sudden fluctuations are unnerving, but clients are settling into the changes and learning how to pivot. Many now see this as their opportunity to get into the market.

M: Buyer psyche also plays a part. I was working with several buyers who decided to pause. Now they’re back because they see a more balanced market and a more favourable negotiating environment where they have some leverage.

Even though rates are up, prices are down. In some instances, mortgage payments are the same or even lower than earlier in the year when rates were lower, because housing prices were 15-20 percent greater. So naturally, the question everyone is asking is: Will rates keep increasing?

A: It's hard to predict. The Bank of Canada considers its “neutral rate” between 2 and 3 percent. Within this range, interest rates aren’t so low that they encourage borrowing but aren’t so high that they’re restrictive. The current bank’s key rate is just above that zone at 3.25 percent. While some experts believe that inflation has peaked, we are nearing the end

of the rate-hike cycle. It might not be enough for the Bank of Canada to hit the brakes just yet – we could see higher rates in the short term until inflation is tamed.

M: What does an interest rate increase mean for one’s mortgage? What different types of mortgages are available?

A: Not everyone will be equally impacted by rate hikes. Generally, first-time homebuyers and those with existing variable mortgages are most affected. The two main mortgage rate options are variable and fixed. A variable rate fluctuates throughout the term. While there’s some risk, this is an attractive option for many people because of the lower initial interest rate compared to a fixed-rate mortgage. There are also ways to mitigate risk: some lenders offer a variable-rate mortgage with a static payment. In this case, you wouldn’t have to worry about a fluctuating payment and would still take advantage of the flexibility of a variable product. The other option would be a fixed-rate mortgage, so you know exactly what your payments will be for the duration of your term. This offers some peace of mind – a fixed rate acts like a built-in insurance policy to protect against possible rate increases during your term. But there are some downsides: this option typically comes with higher penalty calculations if you need to break mid-term, sell, or want to switch lenders. If rates fall and you want to break for a better rate, you could face a hefty payout.

M: How do you decide what type of mortgage is right for you?

A: Consider your individual financial budget from a cash-flow perspective. Based on this, you can create a plan that is comfortable and affordable for you. And remember, there are always options. If locking into a fixed rate will help you sleep at night, consider a short-term fixed rate rather than committing to a five-year term. This allows you to reassess in one, two, or three years while also giving you peace of mind.

Your ideal mortgage also depends on other factors, like whether you plan to move or refinance in the short term. If so, you don’t want to be stuck with a longerterm fixed rate.

Looking a few years ahead can help you mitigate risk. Remember, there are penalty calculations to consider. Breaking your mortgage on a variable rate will typically cost about three months of interest. In contrast, the penalty for a fixed rate is calculated as an interest rate differential – often much higher.

M: It sounds like a fixed rate offers more stability. Is this a good solution for people who want to protect against rate volatility?

A: It can be an excellent option for those anxious about fluctuating rates. Fixed rates are based on the Government of Canada bond yields rather than the Central Bank. In July, bond yields fell under 3 percent, which could mean the 3.59 percent level reached in June may have marked the peak for the year. So we may see fixed rates come back down before any softening on the variable or prime rate. We’ve already seen a drop in insured fixed rates and could hopefully see all rates come back down over the next 18-24 months – maybe even sooner.

M: What should people do if they currently have a variable rate?

A: For existing variable-rate holders, I’d say budget and prepare for more fluctuations. You’ll have to embrace the increases over the short term, but you’ll benefit when rates inevitably decline. Statistics show that variable-rate holders save more over time if they can stay the course.

If you’re considering converting an existing variable mortgage to a fixed one, you could take a rate of at least 5%. If you’re willing to do that, the next logical question is: What if fixed rates start to decline? Consider this. What if you were to take a five-year fixed rate today, but rates come down in 2024 – are you comfortable with that risk? We’ve seen this happen before.

While we’re experiencing volatility now, there are perks with a variable rate – especially for those who may be able to weather the short-term increases. But it’s worth noting: if you’re someone that panics every time the Central Bank meets to announce its policy rate, a variable rate may not be the best product for you.

M: What advice do you have for firsttime homebuyers entering the market?

A: If you want to enter the market today, you have to determine a realistic plan. Look at your affordability and decide based on that. Mortgages are a long-term commitment – you’re probably in it for the next 20-30 years, not just the next three to five. If you’re a first-time buyer who has been struggling to enter the market, this could be your window of opportunity. You might take a slightly higher rate today, but that could change when you come up for renewal.

M: Yes – more leverage, opportunities for conditional offers, and better negotiating conditions in a more balanced market has enormous upside. Are there other strategies people can use that might mitigate some risk down the road?

A: Of course. One possibility is to make additional principal payments if your plan allows – this will reduce your interest over time. But of course, this can be hard to do when rates are high. A good strategy is to take advantage of prepayment privilege. This is where the lender allows you to prepay a portion of your principal mortgage as either a lump sum or an increased percentage of your regular payment. It’ll chip away at your principal and knock down the amortization or life of the loan.

M: Whether someone is deciding between a fixed or variable mortgage or contemplating getting into the market, what’s your biggest takeaway?

A: Never make a decision based on fear. We’re bombarded with alarming headlines, and our reactionary instinct might be to prioritize short-term gain. Instead, figure out what you can afford by looking at your short and long-term goals. The volatility that worries some might present an opportunity for others, so deciding whether or not to lock in depends entirely on you. If you’re ready to commit to or want to change your mortgage, it’s important to sit down with a professional and create a plan that will best suit your needs.

Want to learn more? Connect with Matt at 416.937.6293, insidewithmatt.com

Connect with Angie at 416.315.6261, angie@capitalhomelending.ca