Yesterday’s announcement from the Bank of Canada suggested that interest rates could remain neutral for a while.
The market agrees, with traders anticipating little movement in the federal funds rate this year, according to the latest forward rate data from Candeal DNA.
“Overall, the case for further (monetary) easing is weak,” Claire Fan, senior economist at RBC, wrote yesterday, echoing the sentiments of most of her colleagues.
This is all a disappointment to the many who have ridden the variable rate roller coaster lower over the past two years in the hope that the ride would last longer.
Many were betting hard that high interest rates, a shrinking population and/or Trump’s sledgehammer-like trade tariffs would devastate the Canadian economy far more than reality suggested.
Instead, macro data has exceeded forecasts and – pandemic aside – leading indicators from the OECD predict that much of our economy could grow at its fastest pace since 1994.
To be sure, a chorus of cautious analysts continue to insist that Canada’s economy is weakening quickly. In fact, many have been singing the same tune since last spring, but somehow the patient is still upright and breathing.
Meanwhile, people with mortgages aren’t exactly benefiting from this supposed economic downturn. The average cost of borrowing is almost the same as it was in March of last year, when Trump’s tariff circus caused a stir.
The popularity of the variable is increasing
The proportion of borrowers choosing variable interest rates has increased.
At least 35 per cent of prime mortgage buyers signed up for a variable last year, according to figures from the Bank of Canada.
Fast forward to now: Real-time data from Dominion Lending Centers Group — a good indicator considering it’s the country’s largest mortgage lender — suggests that half of new prime mortgage applications this month were for variable rates.
But if economists are right that rates don’t have much room to fall (unless there’s a shock), should more borrowers pay longer, closer attention to lock-in?
That’s a fair question, considering that the average variable interest rate last year was Prime minus 0.75 (which is 3.70 percent today). In comparison, current fixed interest rates at competing lenders are only a quarter point (25 basis points) higher.
In other words, the price of security is cheaper than usual.
Of course, if you somehow knew that the Canada-United States-Mexico agreement was about to unravel and send the economy into a downturn, or that another recessionary shock was imminent, locking it in would make far less sense.
But omniscience is in short supply, and betting on disaster to lower interest rates is a gamble. In fact, it’s more of a “gamble” than paying an extra 25 basis points for the security of a fixed rate.
This is particularly true given that risk now looks significantly asymmetrical. That means the pain of locking in and missing out on a few more rate cuts is less than the pain of wavering and being exposed to many more rate hikes.
Regardless, you can only get so far with crystal clear future interest rates. The choice of term is a complex decision. To help you, here are seven reasons to consider a lockdown and five reasons not to.
Get a three to five year contract term when you…
- You need budgetary security because cash flow is tight or income continuity is questionable
- You can get an exceptionally fixed interest rate of three (this is easier said than done if you already have a variable mortgage)
- I don’t want to worry about mortgage rates by 2030
- Need financing for the entire term (three years, five years, etc.) and don’t pay it off early
- Believe in the forward interest rate markets, fallible as they are, that price in rate increases of 100 basis points over the next five years
- It’s not easy to qualify for a mortgage again
- Can find a lender with a flexible porting policy (assuming you may be moving before your term ends)
Choose a variable if you…
- You can get an exceptional discount (Prime minus 100 basis points or better) and afford the risk of rising interest costs
- You want to take advantage of the historical opportunities that variables typically outperform over complete cycles
- Trust governments to curb spending and control inflation
- Strict fixed interest penalties for early breakage must be avoided
- Want to bet that you can time a future interest rate lock-in (this is the worst reason of all – unless perhaps you are an experienced bond trader who keeps an eye on the fixed income markets)
Keep in mind that variable interest rates (as opposed to “adjustable interest rates”) lock in your payment from the start, protecting you from some payment risk—unless interest rates rise to the point where you can no longer cover the interest. In this case, most lenders will increase your payment to at least cover the interest due.
Of course, when you buy a mortgage, you don’t have to bet the farm on a single outcome. With hybrid mortgages you can split the difference partly fixed and partly variable. This underrated solution means you don’t have to guess which horse will win.
Whatever you do, don’t choose a floater just to save a quarter point up front. More and more people are taking exactly this step shortly before interest rates rise. You might as well collect pennies in front of a steamroller.
Robert McLister is a mortgage strategist, interest rate analyst and editor of MortgageLogic.news. You can follow him on X at @RobMcLister.
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