Uncertainty about interest rates will continue to be the bane of home buyers and owners with a renewing mortgage in 2024, but rate-hedging strategies can help borrowers limit that risk, experts say.
Over the past couple of years, the uncertainty was about how quickly and how far borrowing costs would rise. The Bank of Canada was rapidly hiking its trendsetting interest rate – which rose by 4.75 percentage points between March, 2022 and July, 2023 – in an effort to disincentivize spending from consumers and businesses and cool inflation.
Now, with the economy slowing and price pressures easing, the question is exactly what trajectory interest rates will follow on their way down.
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First, there’s the issue of when Canada’s central bank will start lowering its policy rate, which directly affects variable mortgage rates. Economists generally don’t see the cuts starting until June or the second half of the year. The bond market, on the other hand, until recently expected the cuts to begin as early as April, although traders significantly revised those odds last week after a series of data releases pointing to persistent inflationary pressures in both Canada and the U.S.
What bond traders believe the Bank of Canada will do is the second source of uncertainty for anyone who needs a new mortgage. Those beliefs affect bond yields, which, in turn, impact lenders’ borrowing costs and what they charge borrowers on new fixed-rate mortgages.
While bond yields have been trending lower in anticipation of the Bank of Canada’s cuts, this is happening as a “zigzagging” downward sloping line, said Robert McLister, a mortgage analyst. This reflects bond traders continuously adjusting their expectations and means fixed rates may see a number of small, short-lived increases, even as interest rates broadly move lower. Those temporary bumps could prove costly for borrowers who lock into a fixed-rate mortgage at the wrong time.
So how can home buyers and owners hedge their interest-rate risk?
Here are four strategies mortgage experts point to.
Use multiple rate holds
With a mortgage pre-approval, lenders guarantee a given fixed rate on a new mortgage for up to 120 days. Getting a rate hold early protects you against any temporary increases that may happen before you sign off on your new mortgage, said James Laird, co-chief executive officer of financial products comparison site Ratehub.ca and president of mortgage lender CanWise.
Even better, if rates decline before your renewal date, there is no commitment to stick with the rate that’s being held, Mr. Laird added. Instead, you can ask for another hold on those lower rates. Borrowers can have multiple holds at different lenders, he said.
“There really is no downside risk to getting rates held for yourself early and often,” Mr. Laird said.
Go variable
Opting for a variable-rate mortgage eliminates the risk you’ll be stuck with a high mortgage rate as borrowing costs fall, but you’ll face the uncertainty of how long rates will remain at elevated levels.
That’s not to mention the fact that variable-rate mortgages right now are generally higher than what lenders are charging on fixed-rate loans. This week, for example, the lowest nationally available variable rate on loans that don’t require default insurance is 6.55 per cent, compared with 5.34 per cent for a five-year fixed rate, according to MortgageLogic.news, an industry bulletin run by Mr. McLister.
Finally, there’s also the risk that rates will climb further. Mr. McLister points to an early December estimate by Harvard economist Jason Furman that there was then a 25-per-cent change that inflation will reignite in the U.S. A considerable reacceleration of consumer prices growth in North America would lead to further hikes in the U.S. and Canada, Mr. McLister cautioned.
Going variable makes sense “assuming you can handle the risk of being wrong,” he said.
Choose a short-term fixed rate
If you need a new mortgage now but believe rates will fall in the near future you could also lock into a one-year fixed rate, Mr. McLister said.
Such rates are currently significantly higher than those on mortgages with terms of five years. But if rates do decline over the course of the year, “then paying more for a one-year fixed mathematically works out better than locking yourself into a five year fix,” he added.
Go hybrid
Another option is to choose a hybrid mortgage, or what Mr. McLister calls “rate diversification.” This lets you split your loan into two or more portions tied to variable as well as fixed rates.
The variable-rate part allows you to take advantage of lower borrowing costs if rates fall. The fixed-rate portion limits your risk should rates move in the opposite direction.
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Erica Alini