Faulkner: How to choose between fixed or variable mortgage rates

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Today, across Canada, we are seeing a very large gap between fixed and variable mortgage rates.

A fixed mortgage is a mortgage where the interest rate stays the same for the term you choose, with the most popular terms being three and five years. A variable mortgage will fluctuate up or down based on the Bank of Canada overnight rate.

Over the past several years, the difference between the two mortgage types has been modest, and home buyers have simply chosen the one they felt most comfortable with. Today that gap can be nearly three-quarters of a percentage point.

Fixed mortgage rates track the five-year Government of Canada bond yield, and that yield has climbed recently for a few reasons — mainly rising inflation expectations (partly driven by oil prices) and pressure from global bond markets, including the United State. As bond yields rise, lenders’ funding costs go up, which pushes mortgage rates up as well.

And as government debt rises, bond rates face more upward pressure to attract buyers and absorb the higher supply of bonds governments need to sell. As a result, we are seeing a much larger difference between fixed and variable rates today.

On a $400,000 mortgage amortized over 25 years, the difference in payment could be as much as $165/month. At the end of the five-year term, you would also have paid off an additional $4,527 of your mortgage because of the lower interest rate.

The above calculation assumes the variable rate remains the same over the five-year term, which is highly unlikely. There’s real uncertainty about which direction the Bank might move at the next rate announcement on Oct. 28.

Choosing between a variable or fixed-rate mortgage can feel a little like sitting at the roulette table and betting everything on black.

This decision is best made after consulting with your mortgage specialist or broker. Your risk tolerance and financial ability to pay higher mortgage fees should the variable-rate mortgage increase significantly will be factors to consider in your decision.

Some lenders will only increase the payment on a variable mortgage if the overnight rate increases significantly. You would still pay the higher interest; it would simply mean less of your monthly payment goes toward paying down your mortgage principal.

Angela Robinson, a mortgage broker with BRX Mortgage, says, “One option to consider is a static-payment variable mortgage, offered by select lenders. Your regular payment amount stays the same as rates move, providing more payment and budget predictability while still benefiting if rates fall. However, there is still risk if rates rise significantly, including reaching a trigger point that could require increasing your payment.”

Many lenders will give you the option to convert your variable mortgage to a fixed-term mortgage at any time. This may sound attractive; however, you may end up paying posted rates, which are often higher than what your lender offers you at your initial application. Also, if you want to switch when the variable rate goes up, the fixed rate may have climbed higher by then, and you might be better off riding out the variable rate for the balance of the term.

Another factor to consider is that payout penalties are often lower with a variable rate if you decide to sell your home before the end of your mortgage term.

Historically, variable rates have averaged lower than fixed rates; however, that doesn’t mean they will in the foreseeable future.

Whichever way you decide, there is risk. Talk to your mortgage specialist or broker, and understand what you’re actually signing up for. The best call might be the one that lets you sleep at night, not just the one that looks best on paper today.

Dennis Faulkner, B.A. Economics, works as a realtor at eXp Realty. He can be contacted for a free market evaluation and to answer your real estate questions at dennis.faulkner@icloud.com