It’s an interesting time to be shopping for mortgage rates. On the one hand, the Bank of Canada’s emergency rate cuts have slashed its key lending rate to 0.25 percent. The big banks followed suit, dropping their prime lending rates by 1.5 percent. On the other hand, bond yields have dropped to historic lows, which should send fixed mortgage rates down – but that hasn’t been the case.
Here’s what you need to know when renewing your mortgage this year.
Variable rates vs. Fixed rates
A quick explanation of variable versus fixed rate mortgages.
Variable rates are tied to the Bank of Canada’s key interest rate and typically move in lockstep when the central bank raises or lowers its interest rate. That affects the interest rate on a variable rate mortgage, or on a home equity line of credit.
Fixed rate mortgages are influenced more by the bond market – in particular five-year government of Canada bonds.
In both cases the bank borrows money at rates slightly higher than the government rate, and profits from the spread between their borrowing and lending rate.
With that out of the way, how should homeowners facing a mortgage renewal this year tackle their decision? Mortgage renewals typically come down to timing. No one is going to successfully select and carry the lowest possible mortgage rate throughout their entire term.
That’s why I adopt a mortgage renewal approach that looks for the lowest of either the five-year variable rate mortgage, or a 1-2-year fixed rate mortgage.
My thought process is that if a large variable rate discount (prime minus 0.8 percent or better) isn’t available, then I’ll take a short-term fixed rate and hope for better variable terms in another year or two.
This process has served me well over the life of my current mortgage. I started with a five-year variable rate of prime minus 0.8 percent, which gave me a rate of 2.15 percent in 2011. One rate cut took that down to 1.90 percent for some time.
Variable rate discounts had all but dried-up when it came time to renew in 2016. Our bank was offering a measly prime minus 0.10 percent (2.6 percent at the time). So, I opted for a 2-year fixed rate mortgage at 2.19 percent.
Fast forward to 2018 and those sweet variable rate discounts came roaring back. I once again chose a five-year variable mortgage rate – this one at prime minus 1.15 percent. With the recent Bank of Canada cuts my mortgage rate is now an incredibly low 1.45 percent.
How does this help you?
If you’re renewing your mortgage, start with the basic premise that borrowers who choose a variable rate mortgage typically save more money (nine times out of 10) than fixed rate borrowers over the life of their mortgage. Then add the idea that negotiating your rate often is a good thing.
Finally, understand that in some years the variable rate discount is largely non-existent, and so it’s not a bad idea to go with a short-term fixed rate so you have the opportunity to hunt for bargains again in the near future.
Renewing Your Mortgage This Year?
I reached out to Rob McLister, mortgage expert and founder of RateSpy.com, to ask specifically what else homeowners should be looking for when it comes to renewing your mortgage this year.
Rob’s on the ground dealing with mortgage applications and he understands both the interest rate and lending environment we’re facing right now.
Should I shop early and take advantage of rate holds?
Mortgages are taking longer to close in some cases due to COVID-related inefficiencies. Make sure you apply to renew your mortgage at least 35-40 days before renewal.
It typically pays to lock-in a rate sooner than later in case rates shoot up. But, in a recession where the government is adding massive amounts of liquidity to the system, there’s less chance of rate spikes.
There’s a greater probability in the near-term that interest rates just drift sideways or move lower as bond investors price-in falling growth and deflation risk, and as investor demand for mortgages improves in the mortgage funding market.
Should I go with a fixed or variable rate?
Well-qualified borrowers can pick up five-year fixed rates as low as 2.14 percent, and variable rates as low as 1.95 percent.
Uninsured borrowers (applies to purchases of $1M or more, rental properties, or amortizations longer than 25 years) are finding as low as 2.44 percent fixed and 2.25 percent variable.
The upfront edge of a variable rate has faded significantly in the last month or so. To put it another way, you’re now paying a lot less for fixed-rate “insurance.”
Typically that happens when the market expects rates to stay low for a few years or more. But humans, being risk averse creatures, tend to weight risk management more heavily than historical rate patterns. As a result, we could see a shift towards fixed rates until that spread between fixed and variable rates — or long-term and short-term rates — widens out more.
At this point, someone going variable would have to be very comfortable with the potential of a 75-100 basis point rate increase in a few years. In fact, if we get more than one rate hike anytime in the next three years, a 5-year fixed rate mortgage would outperform based on interest costs alone.
But the conversation doesn’t end with interest cost. You’ve also got to factor in prepayment penalties, which can be two to four times worse with some five-year fixed rate mortgages, especially at the top 10 banks. Penalties factor in if you move or refinance and can’t get good rates from your existing lender, or if you sell and don’t re-buy soon after.
My existing rate is extremely low. Should I still consider locking-in a rate now?
Variable-rate discounts have slowly improved after almost disappearing in March. At the time, investors were panicked over a potential surge in credit risk. Today, the government is buying mortgage and fixed-income assets by the billions and risk premiums have subsided. That’s pushed down lending costs and banks are starting to pass the savings back to borrowers.
We’re not out of the woods yet, however. Credit risk and rate premiums could always flare back up, but the probability is now greater that variable rates will improve by September.
If I had decided to go variable, then I’d wait as long as I could to set my rate, and ask a mortgage broker to inform me immediately if rate discounts start to shrink again.
If a five-year fixed were more suitable, I’d keep an eye on bond yields. If Canada’s 5-year government bond yield closed above 0.60 percent then I’d apply immediately to lock-in a rate hold.
What’s the rate and lending environment today, compared to five years ago?
Five years ago (May 2015) the average 5-year fixed rate was 2.64 percent at the major banks. Today it’s exactly the same at 2.64 percent. There is virtually no renewal risk for qualified borrowers closing on a fixed rate mortgage in the next few months.
For variable-rate borrowers, they’re seeing about a 20 basis point reduction in rates versus five years ago.
Unfortunately, not everyone is a well-qualified borrower, especially with COVID impacting people’s employment. For anyone renewing near-term who’s seen income interruption or has other credit challenges, you may be better off just renewing with your existing lender.
But talk with a mortgage broker to make sure there’s not a better option given your circumstances.
There’s a lot more that goes into a mortgage decision than simply getting the lowest interest rate. There’s variable rates versus fixed rates, short terms versus long terms, not to mention other mortgage features such as pre-payment and double-up privileges, and pre-payment penalties to consider as well.
Not to mention your own personal financial situation. How stable is your income? Has anything changed since your last term, such as marriage, children, divorce, or a career change that may impact your finances today?
Whether you’re renewing your mortgage with a fixed or variable rate term, know that interest rates are still at historic lows and well under 3 percent. As long as your finances remain in good shape, you can renew your mortgage with confidence without agonizing over 10 or 20 basis points.