Everyone is talking about rates going up these days. And variable rate is great when the Bank of Canada is keeping rates low but now, people are scared because it’s finally time rates are rising. People are panicking and wondering, "Should I turn my variable rate mortgage and convert it into a fixed rate?" Let’s go over your options!
If you have a variable rate mortgage, chances are your current rate is probably around 1.50%. Some of you may be less, some higher…regardless, we’ll use 1.50% as an average. So, what are fixed rates at right now? We’re looking at around 3%.
You’ll notice that the spread is quite high. 3% - 1.5% that’s a 1.5% difference. Why is that? It’s because variable rate and fixed rates are determined differently. Variable rate is determined by the Bank of Canada. Fixed rates are determined by the bond market. Usually, the spread between variable and fixed rates are usually about 0.25% difference, but why is the spread now 1.5%? It’s because the Bank of Canada has been artificially keeping the variable rate low and not adjusting it according to the market. Fixed rates on the other hand, have gone up! You’ll notice that the stock market is back to pre-Covid, if not even higher so the bond market needs to increase its rates higher to attract investors to invest in bonds. Hence, fixed rates are going up!
Now, back to the original question. Should you leave your variable rate mortgage or should you turn it into a fixed rate mortgage? My advice is to leave it. It comes down to math. Why pay more when you don’t have to? Well, it’s because rates are rising! I’m scared! OK, let’s calculate how much more you need to pay.
On a $500,000 mortgage, if your rate is at 1.50%, your mortgage payment is around $2000. If we convert it to a fixed rate mortgage at 3%, your new mortgage payment will be around $2370. That’s a $370 difference per month. Per year, that’s $4440!
That’s the price you are paying more for a peace of mind. Is it really worth it? To me it’s not. That’s a huge jump!
So what am I advising clients to do? Save that money and put it directly into the mortgage instead. Let the Bank of Canada increase its rates. Every time they increase, it’s usually by 0.25%. That means if your rate increases by 1.50%, which is the spread between fixed and variable, the Bank of Canada needs to increase by 6 times. That normally takes about 2-3 years. So, we can’t control how much or how fast rates increase but what we CAN do is control your mortgage balance. If you’re concerned about rates increasing, pay more into your mortgage in anticipation of a higher rate. When your rate is higher, that’s OK but it’s being charged on a lower mortgage balance. So essentially, you’re trying to offset the interest rate increase. Banks allow you to pay your mortgage down faster either by increasing your payments or by lump sum payments without a penalty up to a certain limit.
An analogy I love to use is filling up your car with gas. For those with electric cars, sorry, you probably can’t relate. Say there’s a gas station selling gas at $1.50 per litre. Across the street, there’s another gas station but it’s selling it at $3.00 per litre. Which one will you choose? You’ll for sure go for $1.50 per litre because it’s cheaper. And if you choose the $3 per litre, the people there will be scratching their heads and be like…"What? You want to pay more? OK, sure…." and then not only that, you’re asking if there’s a penalty or extra service charge to buy expensive gas. Of course not! They’d love to take your money because they’re charging you a huge premium.
Very similar to a mortgage - save now. Keep the cheaper money. And if you really want to convert to a fixed rate, there are no penalties. Banks will LOVE it because you’re walking in begging to pay more.
And there you go! We just went over whether you should leave your variable rate mortgage or turn it into a fixed rate mortgage.
Still having trouble deciding what to do with your existing mortgage or have more questions regarding your current situation? Please reach out to us and we'd be happy to help!