Welcome to Mortgage Rundown, a quick take on Canada’s home financing landscape from mortgage strategist Robert McLister.
Mortgage experts constantly refer to historical research when recommending mortgage terms. But history is a funny thing. It continually repeats – until it doesn’t.
When it comes to selecting a mortgage term, borrowers can no longer rely as much on the historical advantage of variable rates.
Consider the difference, or “spread,” between fixed and variable rates. It currently sits at 150 basis points. (There are 100 basis points – bps – in a percentage point.) You have to go back to 2011 for the last time five-year fixed mortgages cost this much more than variable mortgages.
But if we go as far back as 1991, when the Bank of Canada started inflation targeting, there have been multiple cases where the fixed-variable spread was as wide or wider than it is today.
Mortgages 101: What’s a mortgage and how to choose between fixed and variable rates in Canada?
In every case, you would have done better over five years in a variable. That’s what history tells us.
Here’s the ‘but’ …
There have also been five-year stretches when a longer-term fixed has outperformed a variable. The last time it happened was November, 2016, shortly after the U.S. presidential election, when a story I wrote began: “Donald Trump might have just made this month the best time ever to get a five-year fixed mortgage.”
I made a similar call in February, 2021, advocating five-year fixeds for most borrowers. We’ll see how that call turns out, but so far so good.
Fast forward to today. At three-decade highs, inflation is far hotter and more persistent than almost anyone thought.
Despite assurances from the Bank of Canada that inflation will “ease towards” the 2-per-cent target within a few years, the bank’s past bungled consumer price index forecasts prove that it just doesn’t know.
For variable-rate mortgagors, the real risk is that higher inflation expectations “lead to more pervasive labour costs and inflationary pressures,” something the bank worries “could become embedded in ongoing inflation.”
If that happens, throw history out the window. You’ll be very glad you’re in a five-year fixed under 3 per cent.
What the Street says
Derek Holt, head of capital markets economics at Bank of Nova Scotia, was one of the first economists to predict rate hikes of 200-plus basis points in the next few years. And the market itself is even more bullish on rates.
“Swap market proxies indicate that the BoC’s neutral rate is approximately 2.5 per cent,” Mr. Holt said in an e-mail.
If Canada’s overnight rate follows this path, it means the Bank of Canada will have taken rates all the way back to its long-term estimate of “neutral.” In that case, fixed-rate mortgages would have at least a slight edge over variables in interest cost. That’d be true even if the bank cuts rates 100 basis points during the last 12 to 18 months of a five-year mortgage term – which is a real possibility.
Timing matters
There are two big differences between today and when I was pounding the drum on fixed rates in 2016 and 2021.
For one, and this is key, the fixed-variable spread in both my historical examples was minuscule – not far from zero in fact. By contrast, today’s 150 bps spread means fixed mortgages cost much more than variable rates. This gives floating rates a big head start, which lowers the chances that a five-year fixed will outperform.
Second, countless Canadians are significantly more leveraged than they were, even just a few years ago. That means rate hikes will slow the economy quicker and may need to be reversed sooner.
That’s not to say locking in won’t beat floating over the next five years. It’s just that the probability of success in a fixed has fallen.
For all anyone knows, above-target inflation could linger far longer than the central bank’s latest (revised) forecast suggests, requiring 200-plus bps of hikes.
Given that risk, and given the future’s opacity, less qualified, less financially secure borrowers should still buck the historical floating-rate advantage and consider a fixed.
But if you lock in, favour those lenders with fair prepayment penalties. That could save you big bucks if you have to restructure your mortgage before five years.
For the rest of us, a hybrid mortgage like HSBC’s, one that’s half fixed and half variable at around 2.17 per cent, continues to be one of the best ways to play the unknowable future.
Mortgage rates this week
The price of “security” just went up again. Canada’s lowest widely available five-year fixed jumped 10 bps this week, to 2.89 per cent (uninsured). The lowest national available variable rate held steady at 1.39 per cent (uninsured). As noted above, that puts the gap between the two at a new decade-long high of 150 bps.
Rates shown are as of Wednesday from providers that advertise rates online and lend in at least nine provinces. Insured rates apply to those buying with less than a 20-per-cent down payment, or those switching a pre-existing insured mortgage to a new lender. Uninsured rates apply to refinances and purchases over $1-million and may include applicable lender rate premiums. For providers whose rates vary by province, their highest rate is shown.
This & that
· If the BoC hikes rates 25 bps in March, as the market projects, don’t expect banks to increase prime rate by less. Some think they should, in order to “give back” the 20 bps of rate cuts and 25 bps of rate cuts the banks pocketed in 2015 and 2009 respectively. But I’m here to tell you – they won’t.
· Competition is saving people money on variable-rate mortgages. According to a National Bank Financial report, markups on new variable rate mortgages are the smallest on record. In fact, the spread between new variable rates and the Bank of Canada’s overnight rate is two standard deviations (or 70 bps) below its roughly 190 bps historical average, NBF says.
· Lenders are increasingly advertising special rates for large mortgages, like $750,000 and above. If you’ve got a big loan, always ask for and expect better pricing. The discount should be at least 5 bps off the provider’s normal discounted rates.
Robert McLister is an interest rate analyst, mortgage strategist and columnist. You can follow him on Twitter at @RobMcLister.
