If you’re shopping for a new mortgage, or coming up for renewal, you likely wish you had a crystal ball. Picking the “right” mortgage rate is tricky at the best of times, but it requires an extra dose of strategy when borrowing costs are trending lower.
Today’s variable mortgage rates remain elevated, and there’s plenty of uncertainty about how much lower they’ll go – and how quickly. Locking into a fixed-rate mortgage, however, could find a homeowner stuck with a high-interest mortgage long after rates start to ease.
So what’s a savvy borrower to do?
A common strategy over the past year has been to take out a fixed-rate mortgage with a shorter term. This offers borrowers the ability to make a change to their mortgage sooner – ideally when rates fall – while providing protection from unexpected rate volatility. A three-year fixed-rate mortgage has been especially popular as an alternative to the traditional five-year mortgage.
But the best time to have taken out a three-year mortgage was a year ago. Today, shorter is better, and flexibility is the name of the game. Two-year fixed-rate mortgages are the new ideal option for borrowers looking to take full advantage of incoming lower rates.
That’s because markets now believe the Bank of Canada will hit the bottom of its rate-cutting cycle in 2025. After promising inflation reports both in Canada and the United States, our central bank is expected to cut its benchmark rate by a full percentage point this year – in the form of three more 25-basis-point decreases – and by another percentage point next year.
That would lower the bank’s overnight lending rate to 3 per cent in 2025, which would be within its perceived “neutral” rate range of 2.25 per cent to 3.25 per cent, the point at which it neither stimulates nor restricts the economy. Should that materialize, the lowest available five-year variable-rate mortgage would be in the realm of 3.95 per cent. Assuming fixed-rate mortgages follow suit, five-year options could be as low as 2.89 per cent.
But many of today’s borrowers can’t wait until 2025 – they’re purchasing a home or coming up for renewal now. For this group, a two-year fixed-rate mortgage will allow them to re-enter the mortgage market at precisely the right time. They can then lock into a much lower five-year fixed rate or perhaps make the choice to go variable.
And, as the spread – the cost difference – between two-year and five-year terms has narrowed, it makes short-term financial sense, too.
One way to determine if you’ll come out ahead with a two-year term is to compare what you’d pay with a traditional five-year mortgage against the two-year plus the first three years of the (hopefully) lower five-year you’d renew into in 2025.
As an example, let’s say you take out a two-year fixed mortgage at a rate of 5.54 per cent (which is 0.89 per cent higher than today’s lowest five-year option). We’ll assume you’re purchasing a house for $696,179 (the national average in June, according to the Canadian Real Estate Association) with a mortgage amortization of 25 years.
Crunching the numbers in Ratehub.ca’s mortgage payment calculator, we find that by the end of the two-year term in 2025, our borrower has paid a total of $94,994 on their mortgage – principal and interest – and has a remaining balance of $620,437.
Now, let’s say our borrower then renews into a five-year fixed-rate mortgage at 2.89 per cent. Three years into that term, they’ll have paid an additional $110,679, for a combined $205,673. The remaining mortgage balance will be $560,767.
If our borrower had simply locked into a five-year fixed during that time frame at today’s lowest rate, 4.64 per cent, they would have paid a total of $217,548 and have a balance of $568,457. Going with a two-year term saves our borrower $11,875 and results in a balance that’s $7,690 lower.
Given this, the two-year fixed-rate mortgage provides the best of both worlds, offering borrowers the ability to adjust in the short term and peace of mind – a best-case scenario in today’s uncertain economic times.
Penelope Graham is the director of content at Ratehub.ca.
