The Bank of Canada may not have raised rates at its recent January meeting, but it’s clear that interest rates are headed higher tout suite. Those with a variable-rate mortgage may be understandably on edge these days, despite the fact many will still come out ahead of a fixed rate, even after several Bank of Canada rate hikes. But I get it, nobody likes paying more in interest. So, what can those with a variable-rate mortgage do to mitigate the effects of any forthcoming rate hikes? Let’s look at a few options.
Ride the wave. Variable-rate mortgages have historically come out ahead vs. fixed rates over the long run. Of course, there are circumstances where this isn’t true. However, as far as history can be a guide to the future, in the Bank of Canada’s last four rate-hike cycles, it has raised interest rates by an average of 144 basis points. The latest market forecasts have the Bank of Canada hiking rates up to five times by the end of this year, or 125 basis points. And an average of big-bank forecasts expects an overnight target rate of 1.75% by the end of 2023…so 150 basis points above today’s rate. With a current average spread between fixed and variable rates of 150 basis points (averaging high-ratio and conventional rates), the likelihood of you breaking even is pretty high.
Lock into a fixed rate. Those who value a restful night of sleep may feel more comfortable locking into a fixed rate before variable rates start to rise. However, nobody can perfectly time interest rate movements and fixed rates have also been rising steadily over the past year. The premium you may end up paying to convert to a “safer” fixed rate could eat away at your expected savings. You’ll also want to review your personal situation with us beforehand, as locking into a fixed rate if you plan on selling or refinancing in the future could trigger a higher prepayment penalty than if you stayed with your variable rate.
Use prepayments as a hedge. For those willing to ‘ride the wave’ and stick with a variable rate over the course of whatever rate hikes may come, you can mitigate rising interest costs by paying down your mortgage more quickly. Prepayments are extra payments in addition to your scheduled mortgage payments, or increases to your regular payments, and are directly applied to your principal balance. One approach is to use fixed rates as a guide and set your payments as if you were paying a higher fixed-rate mortgage, thereby accelerating your principal repayments. However, you need to be cognizant of your lender’s prepayment restrictions, which are typically 10% to 20% of your mortgage balance per year. Maximizing these prepayment privileges can be an excellent way of hedging rising rates, as you’ll be reducing your interest cost, potentially more than any increase as a result of rising rate.
Whether you’re considering riding out the coming hikes, prepaying your mortgage, or thinking about locking into a fixed rate, please give us a call and we'll be happy to review your situation to help you make the right decision.