Let’s talk about locking it in.
Since the Bank of Canada started its rate hike cycle in March, we’ve seen an influx of variable rate holders rushing to lock into more reliable fixed rates. For some homeowners, having the promise of a consistent payment for the duration of your term is absolutely the right decision.
But before you run to turn the lock and throw away the key, consider some factors that could lead to locking in costing you even more in the end.
Yesterday, in it’s final rate update of 2022, the Bank of Canada announced that it would round out the year with one last supersized rate hike of 0.5% - bringing the overnight rate to 4.25% and lender prime to 6.45%. This is the first time that the overnight rate has surpassed 4% in over a decade. If you are currently in an adjustable rate (a variable mortgage with fluctuating payments) then you already know that with each 0.25% increase to the overnight rate, you can expect roughly a $13 increase to your payment for each $100,000 you owe (on a 25 year amortization). This means that the average homeowner with a mortgage balance of $400,000 has seen an increase to their monthly payments of well over $1000 per month. This is type of increase would impact a household’s cash flow even in the best of variable rate (with static payments) then you are likely confronted this winter with your approaching trigger rate.
So of course it makes sense that variable rate holders would want to lock into a reliable fixed rate to save them money - right? Well, not necessarily.
The upsides of locking in
Budgeting:
No matter the economic conditions, having a static mortgage payment that you can rely on to be the same month to month is beneficial when setting your monthly household budget. Even with fixed rates around 5% right now, removing the burden of worrying if your payment will shift again next month will be eased by locking in for a term of 2-5 years.
Monthly cost:
This one is the crux of this decision. If your monthly payment has already increased by over $1000, the threat that it may continue to rise in the future is daunting. Although the Bank of Canada has hinted that it may be done with increases for a while, we still can’t write off the idea that more could come.
If, for example, inflation doesn’t cool as quickly as the Bank would like and we see another 1% increase. If your current rate is 5% on your $400,000 mortgage and you have 2 years left on your term, then you will be paying roughly an extra $5500 over the remainder of your term as a result.
If you chose to lock in today at a fixed rate of 5.5%, on the other hand, your payment would only increase slightly and would end up costing you about $2700 over the next 2 years.
Why might you consider riding it out?
Prepayment penalties:
Prepayment penalties incurred by breaking your mortgage term early are one of the biggest sneaky budget killers in the mortgage world. Too often, homeowners do not consider that should their situation change and they find themselves having to break their fixed term early, they may be handed a bill for thousands of dollars from their lender to do so.
Why does this matter? Because if fixed rates come back down, and you have locked yourself into a 5 year term, then you will be left to decide whether to continue paying the higher rate that you locked into for peace of mind, or dishing out the cash up front to break your term and lock back into a lower rate and smaller payment.
Keep your eye on the bond market:
With all of the attention focused on the overnight rate right now, the trends for fixed rates tend to get glossed over. But we are actually seeing some decreases to fixed rates this month, and can likely expect even more - why?
Fixed mortgage rates follow the trajectory of the 5 year government bond yields. When the price of government bond goes up, the yields go down and fixed rates follow (you can read more about this relationship here).
Because government bonds are a very low risk investment their demand tends to peak in times of economic uncertainty. So, as the Bank of Canada continues to lay the pressure on inflation with higher rates and a recession because imminent, the sale of bonds goes through the roof.
This is why we have already seen some decreases to fixed rates and, after yesterday’s announcement, will likely see more.
If you’re interested in seeing where the bond market is, this is a great website to bookmark. Remember that 5 year fixed rates are often 150bps (1.5%) more than the current 5 year bond yield!
The bottom line
With the bond market heating up in anticipation of the recessionary period and the promise of drops to fixed rates, now might not be the best time to lock in your variable rate mortgage. That’s not to say that staying in a variable option is right for everyone, though. While considering the numbers is important when making these big financial decisions we can’t ignore the emotional factor.
If locking in now will give you peace of mind, then we can look at options for shorter fixed terms to allow you to take advantage of a static payment for a shorter period and be able to renew into a lower rate without incurring fees, for example.
There is no one-size-fits-all solution to navigating times of financial stress but there are professionals here ready to help you make the best decisions for you! Head to the link below to schedule a no-obligation consultation or give us a call today!
