Human psychology is funny. It has the ability to seduce people into prioritizing today's gains over tomorrow's risks.
Take mortgage interest rates, for example.
Currently, typical variable rates sell for about 25 basis points cheaper than most fixed rates, give or take.
This modest range is enough to get many people excited about variables again.
In fact, at Canada's largest mortgage lender, Dominion Lending Centers Group – an anecdotal industry player – 47 percent of prime borrowers adopted a variable rate as of November. This is a significant increase from 25.6 percent in August.
Many of these people are wavering because they believe Canada's economy is circling the toilet bowl – although Friday's 2.6 per cent increase in GDP might make some change their minds, however deceptive the report may have been.
Meanwhile, “the Bank of Canada has indicated that its easing cycle has ended, meaning the next rate change could be a hike,” National Bank Financial (NBF) wrote on Wednesday.
However, mortgage buyers appear unconvinced as they sense there will be major economic shocks in 2026 as the US renegotiates our economic lifeline, Canada
–United States-Mexico Agreement (CUSMA)
. This experience will lead to Trump dictating terms to us or perhaps even threatening not to renew the agreement at all.
But if the bond market is right — don't bet on everything — Canada may have seen its last rate cut of this economic cycle. Many argue that Canada's persistent inflation, rising stock market and massive AI investments support this theory.
While this isn't a particularly strong argument for going variable, many are willing to accept a guaranteed small profit (a lower upfront variable rate) over an unquantifiable probability of loss.
Many mortgage advisors reinforce this line of thinking by touting York University Professor Moshe Milevsky's pioneering studies, which show that depending on the assumptions, variables win more than 77 percent of the time.
Side note: Some mortgage types still cite a 2001 study that says people are better off on some variable nearly 90 percent of the time. But this number is no longer realistic. The spreads between fixed and variable factors in this study do not reflect current conditions, it ignores our position in the interest rate cycle, today's structural inflation risks are different (US trade policy, budget surpluses, etc.) and it does not take into account all interest rate spikes, e.g. B. from
2022 to 2023.
There is also an optimistic bias that drives the adoption of variables when people think, “Interest rates are unlikely to rise much.”
All of this psychology becomes even more pronounced when bond yields rise, making fixed-rate mortgages even more expensive compared to variable ones.
“In 2021
–
In 22, this dynamic led to an increase in variable rate lending just before the Bank of Canada began tightening,” NBF added in its report. “475 basis points,” NBF added in its report. And this time, as then, “we are not seeing a major downward trend in mortgage rates,” it said.
That, of course, is the danger, so here are four things borrowers should keep in mind:
- Yields rise after a rate-cutting cycle primarily because markets begin to price in interest rate hikes from the Bank of Canada, which is why fixed rates become more expensive at the end of a rate-cutting cycle. This makes variable interest rates seem more enticing to new borrowers, and that is deceptive.
- When the central bank begins a cycle of interest rate hikes, it rarely stops.
- The Bank of Canada has failed to bring its preferred inflation measure back to target in over four and a half years. According to official data, inflation is slowly improving, but is still far from being in a good state.
- An upfront interest rate advantage of 25 basis points is tiny, because on an average mortgage of $300,000, you only save $39 per month. The average rate hike cycle since the Bank of Canada began targeting inflation has been 282 basis points.
Of course, there are other reasons for refinancing your mortgage, not least flexibility. Most variable interest rates can be terminated with just a three-month interest charge. Depending on the situation, this is a relatively small fee compared to fixed rates, especially as rates go down (when penalties are highest on fixed rates).
Variables also provide some protection because payments are fixed unless interest rates rise so much that you cannot cover the interest due.
Note: Adjustable rate mortgages, called “ARMs,” are different. You have payments that fluctuate with the prime rate.
Additionally, variables allow you to commit to a fixed interest rate at any time and without penalty. The catch is that it's virtually impossible to get the timing right because bond yields often push fixed interest rates up so quickly that people don't buy into them quickly enough.
Additionally, lenders are notorious for offering below-average fixed interest rates when someone asks for coverage.
In short, the initial interest rate advantage, option value and historical outperformance of a variable are partly illusory.
That doesn't mean well-qualified and risk-tolerant borrowers should avoid them. It's just a reminder that you know what you're getting into and don't let cheaper variable interest rates fool you.
Finally, and you really mentioned this, people don't have to completely commit to fixed or variable values. Hybrid mortgages can give you a taste of both mortgages – e.g. B. half fixed and half variable.
For anyone who wants to have a meaningful mortgage balance in five years, spreading risk over an unpredictable future can be a logical solution.
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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