Why variable-rate mortgages are becoming more attractive to Canadians

Thinking of taking on or renewing your mortgage? You might want to take a close look at variable-rate mortgages, brokers are advising.

Some perceptive homebuyers are already on it.

“We’ve seen increased interest in variable rates,” said James Laird, president of brokerage firm CanWise Financial and co-founder of RateHub, a popular website that allows users to compare mortgage rates and credit cards.

Steve Garganis, a Toronto-based mortgage broker, told Global News via email that he’s also receiving more inquiries about variable rates and expects that trend to grow.

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Fixed rates guarantee monthly payments will stay constant through the duration of the loan. Variable rates, as the name implies, can change.

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Variable rates move in tandem with the prime rate, the interest rate that lenders charge to their best customers. If a lender decides to raise or lower its prime rate, mortgage payments will move up or down according to a predetermined percentage spread over or below the prime. Variable rate-mortgages are inherently more risky and cheaper, than fixed-rate mortgages.

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In 2016, however, the spread between fixed and variable rates was very thin, narrowing to as little as 0.2 per cent of a percentage point, according to RateHub. As a result, Canadians saw little point in taking on the risk of a variable rate. Over 90 per cent of CanWise clients, for example, opted for fixed-rate mortgages.

That appears set to change, for two main reasons:

1. The spread between fixed and variable rates is widening again

The lowest available fixed rate for a 5-year mortgage has climbed by 0.35 of a percentage point since Nov. 1, from 2.09 per cent to 2.44 per cent, according to RateHub.

Five-year variable rates, meanwhile, have been moving in the opposite direction since the beginning of the year. In Toronto, the best available rate on RateHub is now 1.83 per cent.

That spread is already enough to result in material savings, in some cases.

Take the average Toronto home price of $727,920, for example. Assuming the minimum downpayment of 6.6 per cent and a 25-year amortization period, borrowers would save $209 a month opting for the 1.83 per cent variable rate over the 2.44 fixed rate. Over 5 years, assuming no change in variable rates, those savings would grow to $12,540.

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Brokers generally expect the gap between fixed and variable rates to continue to widen this year, for two main reasons:

• Bond yields are rising, pushing up fixed-rate mortgages. Bonds are the main financing cost of fixed-rate mortgages, and lenders have been passing on those extra costs to consumers. Part of what’s putting upward pressure on Canadian bond yields is the U.S. market, where investors expect President Donald Trump to drive up inflation by boosting public spending to stimulate economic growth. When inflation rises, lenders demand higher interest rates to preserve their returns. In the bond market, that means higher bond yields. Also likely to contribute to the trend is the Federal Reserve, which bumped up its benchmark interest rate from 0.5 to 0.75 per cent in December. The Fed is expected to implement further raises this year if the U.S. economy continues to show improvement.

• The Bank of Canada’s benchmark interest rate, which affects variable rates, shows no sign of moving. Unlike the Fed, Canada’s central bank continues to feel queasy about economic conditions in its domestic market and has given no indication that it is going to raise rates. Because prime rates are tied to the BoC’s benchmark rate, there is little foreseeable upward pressure on variable rates.

2. New federal rules have made it harder to qualify for the popular 5-year fixed-rate mortgage

As of October of last year, borrowers who opt for a five-year fixed-rate mortgage have to pass a stress test that ensures they will be able to carry their mortgage if rates rise.

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That’s the same test that borrowers with variable rates or fixed rates for terms of less than five years were already subject to.

The rule change has diminished the appeal of the five-year fixed-rate mortgage for stretched-out borrowers, making it likely they’ll opt instead for a cheaper variable-rate mortgage, said Laird.

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Of course, there is no guarantee that the spread between fixed and variable rates will continue to widen or that variable rates won’t rise in the next few months.

Risk-averse homebuyers might wish to stick to fixed rates, and those who opt for variable rates should ensure they can cope with a rate increase, cautioned Laird.

Still, if your stomach and your wallet can take it, a variable rate might be the way to go this year.