Why You Should Consider a Variable Mortgage Rate in 2021
There is a lot of information, and opinions, available and for many that makes deciding on the best mortgage option confusing. Based on the current environment, I recommend a variable rate mortgage as your best mortgage option. This is due to variable-rate mortgages offer much lower penalties, lower rates (currently 1.29%) and because the Bank of Canada is not increasing interest rates soon.
In my experience, the most important but usually ignored difference between fixed and variable mortgage options is that the fixed-rate mortgage comes with an enormous penalty if you sell or refinance before the end of your term.
Fixed vs Variable Mortgage Rate
If your fixed rate mortgage comes with a penalty in the tens of thousands of dollars, that penalty needs to be considered, in addition to the interest rate you are paying. Statistics show that between 60-70% of mortgages are refinanced before the end of the term and in those cases, the borrowers end up paying a penalty to the lender.
As the economy recovers from COVID, the media has turned to stories about how higher inflation and higher interest rates coming. The same events happened in late 2018, and many fearful clients rushed to lock in 5-year fixed rate from at the time from 3.49-3.69%.
The problem, as many of those clients quickly realized when rate decreased, was that the penalty to refinance would usually offset any savings over the remaining term by switching to a lower interest rate. These (IRD) penalties are especially egregious with Canadian Banks, which is why the big 5 banks need to be avoided entirely if you need the certainty of a fixed rate.
The Bank of Canada has been explicit, and consistent, in telling Canadians that interest rates are not going to go up for at least 3 years from when they were cut last spring. In addition, they are buying billions of dollars of government bonds each week to keep rates low. The Bank of Canada would need to stop buying and sell the bonds the have accumulated over the past year and expect inflation to be above target before raising interest rates would make sense.
Since the Canadian economy is more dependent on housing than ever, higher interest rates would hit the economy quickly. I expect higher taxes Canadians will be paying over the coming years will do plenty to keep inflation low and slow the economy as it recovers from the pandemic.
Today, the best uninsured fixed rates are 0.74% higher than variable (1.29% compared to 1.99%) so if the Bank of Canada started raising rates in years 2 or 3 of a new variable rate mortgage, they would have to raise them by about 1.50% before you would be worse off. In the meantime, with a fixed rate mortgage you would be paying additional interest, with each monthly payment, until the Bank of Canada raises the overnight rate three times.
The solution is simple, avoid the penalties associated with fixed rates and pay less interest over the next 5 years by choosing a variable rate mortgage.
Kevin Bell, CFA