Should you lock in your mortgage rate or renew early before interest rates rise again?
The Bank of Canada (BoC) stayed put today, but interest rates will probably begin to rise again by the end of the year.
The BoC’s so-called policy interest rate, which affects the general level of interest rates in the economy, currently stands at 1.25 per cent, up from just 0.5 per cent in July. The latest increase came in January when the bank implemented its third quarter-of-a-percentage point increase since last summer.
Since then, as was widely anticipated, the central bank has been keeping the pause button pressed, as it waits to know more about the future of NAFTA, the impact of the new federal mortgage rules and other factors that will affect economic growth.
Still, most economists expect the Bank of Canada’s interest rate climb to resume in the latter half of 2018.
CIBC and TD see rates rising to 1.5 per cent by the end of this year and to 2 per cent by the end of 2019. BMO and Scotiabank are forecasting the overnight rate at 1.75 per cent by the end of 2018 and 2.5 per cent by the end of next year. And RBC expects rates to be at 2 per cent by the end of 2018 and 2.25 by December 2019.
That’s food for thought if you have a variable-rate mortgage, and in general, if you’re among the 50 per cent of Canadian mortgage holders whose loan will come up for renewal in the next 12 months.
Should you think about turning your variable rate into a fixed one, or if you already have a fixed rate, try to renew your mortgage early before rates go up again?
Some 30 per cent of Canadians have a mortgage with a variable-rate, which goes up and down with the policy rate. If rates rise, you’ll be paying more interest on your mortgage. If your loan is a so-called adjustable-rate mortgage, your monthly payments will go up. Otherwise, your monthly mortgage bill usually stays the same but more of your monthly payments go toward interest rather than principal. Your lender will usually up your monthly payments at renewal to make sure it doesn’t take you longer to pay off the mortgage.
- Fixed rates are higher than variable rates. Variable-rate mortgages come with the option of switching to a fixed rate during the term of the loan. That can buy you peace of mind but comes at a cost. For one, fixed rates are usually considerably higher than variable rates. All things equal, the wider the spread between your current variable rate and fixed rates, the less reason to switch, McLister told Global News. Also, “the smaller your mortgage relative to your income and the shorter your remaining amortization, the less you’re impacted by rising rates and the less it makes sense to lock in,” he added. For example, someone with a $50,000 mortgage balance making over $100,000 can comfortably afford slightly higher interest rates. The same usually holds for someone with less than 10 years to go to pay off the mortgage: the further along you are, the more of your monthly payments go toward principal rather than interest, so an interest rate hike won’t affect you as much.
- The fixed rate your lender will offer will likely be higher than what you can find elsewhere. Another thing to keep in mind is that you might not be able to convert to a competitive fixed rate. “Conversion rates are never as aggressively priced as those offered to borrowers who have yet to walk through the lender’s front door,” David Larock, a Toronto-based independent mortgage broker recently wrote in a post weighing the pros and cons of fixed- and variable-rate mortgages. Today’s average variable-rate homeowner has a rate near 2.91 per cent, according to McLister. “Someone locking the average 2.91 per cent variable today would get a five-year fixed rate near 3.49 per cent,” he added. The BoC would have to implement three or four hikes of a quarter of a percentage point for a borrower in that scenario to come out ahead, he reckoned. If you want to lock in and can’t pass the new mortgage stress test, you won’t have a choice but to take what you’re offered. However, if you do pass the test, it may make more sense to wait for the end of your mortgage term and then shop around for the best fixed-rate mortgage. This makes all the more sense if your mortgage is close to maturity, said McLister.
- Locking in means higher penalties if you have to break your mortgage in the future. “Locking in can cost you flexibility since variable rates have much cheaper penalties if you need to break the mortgage early,” he added. “Over 40 per cent of [borrowers with] five-year [mortgages] never reach the end of their term. They refinance, increase their mortgage or sell.”
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Over 65 per cent of Canadians have fixed-rate mortgages. If you’re one of them, your rate remains the same through the term of the loan, but BoC interest rate decisions may affect the rate you’ll be able to get at renewal.
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Fixed-rate mortgages tend to follow bond yields, the amount of return investors realize on bonds. One of the things that affect bond yields is investors’ expectations about what the BoC will do with its policy rate. Although five-year fixed mortgage rates don’t necessarily rise ahead of policy rate increases, recently they have. So what can you do if you’re worried about renewing at a higher fixed rate?
- Breaking your mortgage to renew early. You could break your mortgage in order to renew early, before rates rise again. To judge whether that makes sense, you need to compare the extra interest you’d pay until maturity in your current rate to costs of switching to the new rate which includes a penalty and a number of fees, McLister said. And then, of course, there’s the considerable paperwork that comes with changing lenders. Also, keep in mind that you likely won’t be able to transfer to a different financial institution if you can’t pass the mortgage stress test.
- Renewing early without breaking your mortgage or ‘blend and extend.’ Some mortgages have an option to renew early or opt for something called “blend and extend,” which allows you to extend your mortgage term and get a mortgage rate that is a blend between your current rate and the rate you would have gotten at renewal. Both options can be helpful if you’re worried about rising interest rates, McLister said. “Just remember that you may not get the best rates if you blend and extend or renew early.”
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