What’s the risk of you choosing the wrong mortgage rate?

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If you believe what financial markets are telling us, today’s lowest variable mortgage rates will more than double in the next few years.

If that happens, it means the best floating rates for an uninsured mortgage would jump from about 1.34 per cent today to about 3.09 per cent in three years, assuming lenders maintain similar profit margins and the Bank of Canada hikes interest rates as much as expected.

If that’s all that rates increase through 2024, you’d end up with variable-rate mortgages about 60 basis points higher than today’s best uninsured five-year fixed rates. (There are 100 basis points in a percentage point.)

The Bank of Canada has just given mortgage shoppers a strong reason to lock in a rate

Of course, a lot will change between now and 2024. By then, we’ll know how dangerous inflation really was, or wasn’t. And we’ll know how aggressively the Bank of Canada had to hike rates to bring inflation back toward its 2-per-cent target.

Unfortunately, scientists are still working out the kinks on time travel. So we’ll have to rely on what we know today to ballpark how much interest rate risk borrowers face over the next few years.

What we know today is this: Rates are finished going lower, at least materially and sustainably lower for the foreseeable future. The interest rate cycle is firmly on the upswing given the higher risk that the Bank of Canada will lose its battle against inflation in the next 12 months.

Since the dawn of modern monetary policy in the 1990s, past rate-hike cycles have resulted in 75 to 275 basis point jumps in the prime rate. Five-year government yields – which lead fixed mortgage rates – have risen between 125 bps to 200 bps.

Using this history as a very rough guide, and let me underline “rough,” one could expect that hotter and more-persistent-than-expected inflation could theoretically lift variable rates 275 bps and five-year fixed rates 200 bps – or more. Let’s call that the “quasi-worst-case” scenario.

This scenario would result in a roughly $400 increase in the monthly payment on a typical variable-rate mortgage. That’s based on the national average mortgage balance of roughly $304,772, as per the latest data from TransUnion, and a remaining amortization of about 19 years, which is roughly the Canadian average.

If that scenario unfolded over the next three years, today’s best 2.49 per cent five-year fixed would save the typical borrower almost $10,000 of interest over five years versus what is today a 1.34 per cent variable.

If rates only jumped a little more than half that, or 150 bps – which is about average for a Canadian rate-hike cycle – then today’s best fixed and variable rates would end up about break-even. That assumes no prepayment penalties.

So if you’re choosing a variable for the big upfront interest savings, you’re probably hoping the Bank of Canada hikes five times or less. With average core inflation near three-decade highs, is that really a bet you want to make? Only you can answer that one, and only after careful review of your ability to handle the “worst case.”

The variable-rate gap grows wider

Fixed mortgage rates have marched relentlessly higher in the past five weeks. Rising bond yields have forced up five-year fixed rates by 40 bps or more since late September.

Meanwhile, variable rates on new mortgages have moved little, given they’re largely dependent on prime rate. Prime won’t start escalating until at least the first quarter of 2022, according to implied rates in the bond market.

This divergence has widened the gap between the best fixed and variable rates to 115 bps, the biggest it’s been in a decade.

Historically, this wide of a spread drives people into variables, who never would have considered a variable before. But it’s essential to quantify your risk, given your:

• Five-year plan – will you need a mortgage for just a few years, for example? If so, a long-term fixed could cost you in higher interest and breakage fees.
• Financial cushion – will your budget withstand a payment increase of hundreds of dollars a month?
• Mental hardiness – will repeatedly reading about Bank of Canada rate hikes make you a nervous wreck?

The price of fixed-rate “insurance” in the mortgage market is about 100 bps more than it was a year ago, but depending on your circumstances and answers above, it may still be a premium worth paying.

Rates shown in the table are from providers that lend in at least nine provinces and advertise rates on their websites. Insured rates apply to those buying with a down payment of less than 20 per cent, or those switching a pre-existing insured mortgage to a new lender. Uninsured rates apply to refinances and purchases of more than $1-million and may include applicable lender rate premiums.

Robert McLister is an interest rate analyst, mortgage planner and contributing writer for The Globe and Mail. You can follow him on Twitter at @RobMcLister.

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