Robert McLister is a mortgage planner at intelliMortgage and founder of RateSpy.com. You can follow him on Twitter at @RateSpy.
Some variable-rate mortgagors are feeling a bead of sweat after today’s Bank of Canada quarter-point rate hike. The bank’s communications today suggest it’s dead set on “normalizing” rates.
Translation: Today is not the last time prime increases in this rate cycle.
Shrewd borrowers have chosen variable-rate mortgages for years. After all, that’s what the research supports.
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You don’t throw out a good strategy because of five rate hikes in 15 months. Variable rates have exceeded five-year fixed rates in the past, but over any historical five-year period they’ve won out “about 88 per cent of the time,” says Moshe Milevsky, author of Canada’s most cited mortgage research.
And my own simulations confirm it. The best variable rates have beaten the best five-year fixed rates throughout every rate spike since the dawn of modern monetary policy (1991). That’s not a definitive sample size, especially given that rates have been downtrending for decades. But you can’t dismiss it either.
That said, variables won’t always win. At some point, long-term fixed rates will outperform, and that someday may have already happened.
Had you snagged the lowest five-year fixed mortgage in August, 2017, (right after the bank of Canada’s first rate hike of this cycle when five-year fixed rates were about 2.59 per cent) you would now be ahead of someone choosing the cheapest variable at the time (1.99 per cent). That’s based on interest cost alone, not factoring in penalties or refinance costs if you broke your mortgage early.
Could this time be different for fixed rates? Maybe. Blindly expecting to win in a variable based on research is “like saying, ‘Historically, stocks beat the bonds,' ” Mr. Milevsky adds. “That doesn’t mean that every year it’s going to happen.”
Sticking to the plan, or not
For those out mortgage shopping, today’s rate hike is not a game changer. If you can find a variable rate that’s at least 0.75 per cent below a fixed, and you’re well qualified and/or aggressively pay down your mortgage, variables are still worth betting on. “The probability of winning with a variable will likely never fall below 70 per cent," Mr. Milevsky says. “The odds will still be in your favour."
And the higher rates go, the more the probabilities favour variables. That’s largely a result of the tendency of variables to revert to their mean after rising for a while.
But here’s the key to maximizing success in a variable. You must be well qualified, and you must shop rates aggressively. Settling for an average rate can be the difference between winning or losing in any rate you pick. “The bigger the rate discount [on a five-year fixed] the lower the probability” of saving more interest in a variable, Mr. Milevsky says.
Apart from that, deciding on whether to float your rate depends heavily on three things, Mr. Milevsky concludes:
- Are you renewing a mortgage or getting a new mortgage for the first time? (Mortgage experience matters, and the former can usually handle more risk.)
- How much equity do you have? (If you’re highly leveraged with just 5 per cent to 10 per cent down, and “every dollar counts,” fixed is usually wiser.)
- Do you have salary stability? (High unemployment risk, variable income, self-employment and/or income linked to real estate are all reasons to consider locking in, he says.)
Picking a mortgage term is like investing: there are no guarantees. Variable rates are ultimately a risk-return trade-off, Mr. Milevsky says, and every borrower must remember that going in. In the long run you’ll save more in a variable … unless perhaps you were lucky enough to lock in last year.
Robert McLister