With rising rates, which type of mortgage is best for you

 

Last Wednesday, the Bank of Canada increased its overnight benchmark interest rate 50 basis point to 3.75% from 3.25% in September.

That was the sixth time this year the bank tightened the money supply to quell inflation, so far with limited results.

Even though the increase was slightly less than what was predicted, the increase is still causing many pain and concern, particularly if they are currently in a variable rate or adjustable rate mortgage.

Even those with a fixed rate mortgage who are facing a renewal shortly will be looking at much higher rates if they have a five-year fixed term mortgage renewing.

Some of you may have received recommendations from your mortgage broker in the last couple of years to take a variable rate mortgage. This recommendation was based on not only historical data but also the outlook from the Bank of Canada itself.

This is what Tiff Macklem, the governor of the Bank of Canada had to say in October 2020: “What we’re saying is that we are going to get through this but it’s going to be a long slog. We’re telling Canadians, and our forward guidance has been very clear, that we are going to hold our policy interest rate at the effective lower bound until slack is absorbed so that we can sustainably achieve our 2% inflation target, and we’ve indicated that’s not going to happen until sometime into 2023. What does that mean? Yes, that means if you are a household considering making a big purchase, if you’re a business considering investing, you can be confident that interest rates will be low for a long time.”

There was no way for anyone to predict the current direction taken by the Bank of Canada.

So what action if any should you take going forward? You may be wondering if you should now lock-in your variable rate mortgage. There is lots of chatter in the media about the rate increasing again in December and again into next year.

The first question you should ask yourself is why you chose a variable rate mortgage in the first place. Was it because it had a lower rate than a fixed term mortgage or did you have a plan to take advantage of that lower interest rate?

Historically, a variable rate has been a better option by just comparing rates, but those rates can change. Potentially, and depending on whether you have a variable rate mortgage or an adjustable rate mortgage, more of your payment will go toward interest rather than principal if your payment isn’t adjusted accordingly as rates increase.

Another important consideration with variable rate mortgages is they have lower prepayment penalties generally than a fixed rate mortgage should you decide to break your mortgage early. Statistics support that this happens more often than not.

Consumers should evaluate their personal balance sheets and risk tolerance. The decision of whether to go short (variable) or long (fixed) will depend on the consumers’ tolerance for risk as well as their ability to withstand increases in mortgage payments.

You need a plan with a variable rate mortgage. The best thing is to do a review with a mortgage broker to determine your personal tolerance to rate increases and determine a strategy for managing your mortgage to reduce your overall cost of borrowing.

Something to consider about locking in your mortgage is that not all lenders are going to offer you the very best fixed rates. You are also hedging your bet that at some point your fixed rate is going to be lower than a variable rate mortgage.

Perhaps switching to a fixed payment variable might be an option rather than locking into a fixed term mortgage. The best decision is based on your risk tolerance.

No one can predict where rates are headed – even the experts got it wrong! You decision to lock-in to a fixed rate mortgage should not be based on what you read in the media.

If you would like a no obligation review and financial analysis for your personal situation please let me know. We can compare your current adjustable rate mortgage to a fixed term option and even compare it to a variable rate mortgage with fixed payments. That way you can make an informed decision as to whether locking in is the best option for you.

I will do my best to ensure you make the best decision based on today. Please book a time here on my calendar for a chat at www.calendly.com/april-dunn and I’ll do my best to assist.

This article is written by or on behalf of an outsourced columnist and does not necessarily reflect the views of Castanet.

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