Interest Rate Environment

The news of Canada and the US striking a NAFTA deal caused the Government of Canada 5 Year Benchmark Bond Yield to jump 9 basis points from 2.33 on September 28th to 2.42 on October 1st. With the Bank of Canada expected to raise the prime rate on October 24th, the current interest rate environment is clearly in an upswing pattern. What does this mean if you are a mortgage borrower? If you are currently in a variable rate mortgage, you may be wondering if it is time to lock-in, and if you are taking on a new mortgage, you may be contemplating, should I even consider going variable? Whether you have been floating with a variable in the last few years, or are considering a new mortgage, ultimately, it is your own personal risk tolerance and payment affordability that will guide your decision.

Inflation and economic growth are the main contributors to a rising rate environment. The latest inflation report from Statistics Canada shows that while Canada’s inflation is not rampant, it is on the increase. The Bank of Canada has an inflation target of 2%; 2017 was the first time we saw the Bank of Canada raise the prime rate in anticipation of inflation based on economic data from the US.

How high can rates go? Sometimes it is helpful to look at historical rates for perspective; a history of the bank rate from 1935 to 2017 is available here, and a history of 5 year residential fixed rates from 1951 to 2017 is available here. In the last 10 years, the “business” prime rate has ranged from a low of 2.25% to a high of 4.00%; the average was 2.90%, and the current prime rate is 3.70%. Click here to view the history. There is no question that in the short term, higher rates are on the horizon. There is speculation that the Bank of Canada will raise the prime rate 3 to 4 times in 2019. If each increase is 0.25%, that could put the prime at 4.70% this time next year.

As a comparison, today’s rate for a 5 year fixed mortgage is in the range of 3.49 to 3.84%, and variable is in the range of prime less .80, or 2.90%. These are estimates only as factors such as amortization and high ratio mortgage insurance now impact the available rates.

History has taught us that economies do not continually expand. There are natural cycles of expansion and contraction. It is entirely normal for rates to experience upward pressure after a recession; they must go up to allow for future decreases when the economy slows again. Some factors that will act as a headwind to increasing rates are:

  • Higher borrowing costs impact personal and corporate bottom lines. More money paid on interest and debt means less disposable income for spending.
  • A higher prime rate can boost the Canadian dollar. A higher currency value means that our dollar has more purchasing power, which can help with inflationary pressures.
  • A higher Canadian dollar can slow exports which is a contributor to an economic slow down.

When you are considering your choices for your mortgage, a fixed rate mortgage may be a wise choice in this environment if you:

  • Can not handle payment fluctuations.
  • Have a low risk tolerance.
  • Do not plan to make any real estate changes during the length of the term.

A variable rate mortgage may still be the right choice if:

  • You plan to sell the property in the short term. The penalty to pay off a variable rate mortgage is 3 months’ interest, which is a relatively easy exit. The penalty to break a fixed rate mortgage is the greater of 3 months’ interest or the IRD (interest rate differential). This is discussed in more detail here.
  • You have enough income and/or assets to handle payment fluctuations.
  • You are receiving a competitive discount off the prime rate, ie prime less 1.00; a large discount off the prime can offset some of the risk of future increases.

If you are locking in, here are some factors to keep in mind:

  • Try to match the term with how long you think you might be in your home. For example, if you think you might sell in 3 years, consider taking a 3 year term.
  • A fixed term over 5 years, ie 7 or 10 years, has a maximum 3 month interest penalty if the mortgage is paid out after the 5th anniversary.
  • If you have been paying accelerated weekly or biweekly and the higher rates are making it difficult on your monthly budget, consider going back to monthly or semi-monthly payments.
  • When you take a fixed rate mortgage, there is a “premium” built in, like an insurance policy, to have your rate unchanged for the term you’ve chosen.

If you are sticking with variable:

  • Set aside extra funds in your mortgage payment account to get used to a higher payment and to build up a buffer.
  • If you have a variable rate mortgage where the monthly payment stays the same, check with your branch to find out what is the “trigger point” for either an increase in payment or a lump sum requirement, and budget accordingly.
  • Consider increasing the payments  up front to reduce interest costs, especially if you can lower them down the road should the need arise.
  • When you take a variable, you are taking your interest savings up front, and accepting the fact that your payment may change in the future.

The decision is yours to make based on your own personal and unique needs and preferences. What may be the right choice for one, may be completely different for another. What matters is that you are comfortable with your payments and that your mortgage does not keep you up at night.