Source: The Star, By
When my wife and I bought our home in 2011 we chose a five-year variable rate mortgage that came with a deep discount of prime minus 0.80 per cent. The same deal wasn’t available when it came time to renew in 2016, so we went with a two-year, fixed-rate mortgage at 2.19 per cent. Our mortgage is up for renewal again this September and, in the face of rising interest rates, we must decide whether to go with a fixed- or variable-rate mortgage.
We’re not alone with this mortgage decision. A CIBC report estimated that nearly half of all existing mortgages in Canada needed 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 5.34 per cent) or their contractual mortgage rate plus two percentage points.
Borrowers who renew with their existing lender are not subject to the stress test, potential relief for some homeowners who might have overextended their finances when rates were lower. On the other hand, if your bank knows you’re unlikely to shop around at renewal they’ll have less incentive to offer you a good deal on your mortgage.
I’m not worried about passing the stress test because our household finances are in good shape. More important is that we keep our options open so we can negotiate the best deal.
Our mortgage renewal strategy in a nutshell: Select the cheapest of either a five-year variable rate or a short-term fixed rate of one to two years.This strategy is based on research by York University finance professor Moshe Milevsky, whose groundbreaking 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.
Milevsky updated the study in 2008 which showed the probability of coming out ahead with a variable rate had increased to just over 90 per cent, although the amount saved dropped to $20,630. Fast-forward 10 years and the mortgage landscape has changed significantly. Borrowers have more choice today. Instead of blindly accepting a lender’s “posted rate” at renewal, the proliferation of mortgage brokers and online rate comparison sites has made it easier for borrowers to find and negotiate the best mortgage rates. We’re also in a period of rising interest rates. The Bank of Canada has increased its key interest rate four times since last summer, sending variable rates up by one full percentage point. Despite this, Milevsky says to never base your decision about whether to go fixed or variable on where you think interest rates are headed.
Economists and financial analysts often get it wrong, too. In fact, even central banks, “don’t really know what’s going to happen,” he said. 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. Focus on the information at hand today instead of looking at interest rate forecasts. Know your personal financial situation and how a change in interest rates, 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 feel anxious or frustrated about renewing 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. My own research has turned up the best rates on five-year variable rate mortgages, with deep discounts bringing the rate down to the 2.40 to 2.60 per cent range. The best short-term fixed rates came in much higher at around 3 per cent. That’s why I’m leaning toward a variable rate this time around.