Our mortgage comes up for renewal on September 1st. When we bought our home in 2011 I went with a five-year discounted variable rate mortgage at prime minus 0.80 percent. Such a steep discount wasn’t available when it was time to renew in 2016, so I chose a 2-year fixed rate mortgage at 2.19 percent. So, what to with our mortgage renewal now that interest rates have ticked higher?
We’re not alone with this mortgage decision. A CIBC report estimates that nearly half of all existing mortgages in Canada will need to be refinanced in 2018. Adding weight to this decision is a new stress test for both insured and uninsured mortgages where homeowners must prove they can handle payments at the greater of the Bank of Canada’s five-year benchmark rate (currently 5.14 percent) or their contractual mortgage rate plus two percentage points.
Borrowers who renew with their existing lender are not subject to the stress test, which could come as a relief to some homeowners who might have overextended their finances to get into the housing market when rates were lower. On the other hand, if your bank knows that you’re unlikely to shop around at renewal then they’ll have less incentive to offer you a good deal on your mortgage.
Mortgage Renewal Strategy
I’m not worried about passing the stress test because our finances are in good shape. More important is to keep my options open so I can negotiate the best deal.
My mortgage renewal strategy is simple: I’ll take the cheaper of the five-year variable rate or the 1-or-2 year fixed mortgage rate. This strategy is based on what is now decades-old research by York finance professor Moshe Milevsky, whose ground-breaking 2001 study on mortgage rates showed Canadian mortgage holders would have been better off with a variable rate nearly nine times out of 10, saving around $22,000 in interest payments over a 15-year mortgage life.
The study looked at mortgage rates between 1950 and 2000, which critics fairly point out was during a time of falling interest rates. Milevsky updated the study in 2008 and the probability of coming out ahead with a variable rate increased to just over 90 percent, although the amount saved dropped to $20,630.
Fast forward 10 years and the mortgage landscape has changed significantly. Borrowers have more choice today. Rather than blindly accepting a lender’s “posted rate” when it’s time to renew, the proliferation of mortgage brokers and online rate comparison sites have made it easier for borrowers to find and negotiate the best mortgage rates.
There’s also less of a spread between fixed and variable rates, making it less obvious or likely that a borrower would come out ahead by choosing a variable rate.
Finally, we’re now in a period of rising interest rates. During the mortgage wars of the past five years you could easily find a five-year fixed rate mortgage under 3 percent. Today the best offer from the big banks is at 3.29 percent. Meanwhile the Bank of Canada has increased its key interest rate three times since last summer, sending variable rates up by 0.75 percent.
Don’t try to predict interest rates
My mortgage renewal strategy ignores interest rate forecasts and focuses instead on the information at hand today. No one can predict where interest rates are headed, just like no one can predict the direction of the stock market. It’s foolish to even try.
Economists and market experts predicted that rates would go up for years before the Bank of Canada actually lowered rates twice to deal with crashing oil prices. Then, when it was expected rates would stay at historic lows indefinitely, we’ve seen three rate hikes in less than a year.
Whatever you do, Milevsky said, never base your decision of whether to go fixed or variable on where you think interest rates are headed.
“You’re not a bond trader,” he said. And, in any case, economists and financial analysts often get it wrong, too.
In fact, even central banks “don’t really know what’s going to happen.”
All you can do is make the best decision you can with the information you have in front of you. Scour the market for the best fixed and variable rates. Understand your personal financial situation and know how a change in interest rate, term, or amortization might impact your finances. Stress test your own finances to ensure you can handle payments if rates rise 1 or 2 percentage points, or if you lost your job temporarily.
If you’re like me and your mortgage is up for renewal this year you might be feeling anxious or frustrated to have to renew at a higher rate. Take comfort, though, that we’re still in a time of historically low interest rates. There’s also still fierce competition for your mortgage business if you take the time to shop around.
Milevsky says there’s still a place for variable rates:
Because variable rates have been the better deal historically, “I would say go with a floating rate, unless you would be disproportionately affected in a recession,”
I agree, which is why I’ll be keeping an eye on the deeply discounted variable rate mortgages to see if I can get something under 2.50 percent when it comes time to renew my mortgage in a few months.