Penelope Graham
Other
Is it a good time to go with a variable mortgage rate? It’s the age-old question lingering on the minds of home buyers; variable options offer traditionally lower pricing, but are subject to any fluctuation of the Prime rate. However, the most recent Bank of Canada announcement has thrust the consideration back into the spotlight; abandoning their rising rate bias may indicate variable rates have gained a few more years of low-interest certainty.
In the announcement on October 23, the Bank maintained their Overnight Lending Rate, which sets Prime, at one per cent where it has been since September 2010. The monetary policy analysis points to slowing economic growth in Canada and on a global scale, spurred by recent economic and political setbacks in the U.S. As a result, the BoC has backed away from previous attempts to predict a timeline for a stronger economy, meaning current stimulus measures could remain in place until 2015 or 2016, and not end next year as previously anticipated.
As a result, variable mortgage rates may become a more viable possibility for buyers looking for a longer term rate commitment.
Fixed Rates Aren’t Filling The Gap
Low variable rates are made even sweeter by today’s stubbornly higher interest environment. As of today, there’s an 83 basis-point spread between the lowest five-year variable rate at 2.4 per cent, and the lowest five-year fixed at 3.23. While fixed rates dipped moderately at the beginning of the month, they rose again as the U.S. ticked closer to its October 17 debt default deadline. While yields have recovered to three-month lows since, lenders have yet to catch up with fixed rate discounts – after all, they say the banks take the elevator up when it comes to prices, and the stairs down.
The Pros and Cons Of Going Variable
With that spread, it’s tempting to go the Prime-based route. It’s a difference of $157 a month in payments (assuming the average Canadian home value at $368,000, five-year term, 25-year amortization and no CMHC mortgage default insurance—oh, and no change to Prime, of course!). However, determining whether variable is a fit involves more than your comfort with risk and your zeal for discounts.
Con: The Mortgage Qualifying Rate: This may come as a surprise for some first timers—it’s actually more difficult to successfully qualify for a variable rate mortgage. While the rate is lower, buyers’ financials will need to meet the criteria for the bank’s posted five-year rate to qualify. This is to protect buyers’ affordability should Prime rise. The qualifying rate also applies to buyers with fixed terms under five years, in case rates are higher when it comes time to renew.
The government implemented this rule in April 2010 as a response to the U.S. housing crisis unfolding at the time. There, many buyers of promotional subprime rate mortgages found themselves unable to afford their homes when their temporary rate discounts ended, contributing to the onslaught of the Great Recession. Canadian policy makers took heed, and built affordability safeguards right into the qualification process.
Pro: A Longer Low-Rate Outlook: The low interest rate environment is one of the few upsides to stagnant Canadian economic growth. The Bank of Canada cut its Overnight Lending Rate, which sets the tone for Prime and liquidity between banks, at one per cent following the recession in September 2010, to allow for continued spending in Canada and economic recovery. Economists expected our economy to reach capacity in 2014, signalling the end to recovery and the need for such stimulus measures—but that’s now been revised to be a few years down the road. As a result, low variable options will stick around for longer.
Con: It’s Unpredictable: Because variable rates are tied to currently underperforming economic conditions, we can expect them to stay low for a while—but this is also the exact reason they’re so unpredictable. Canada’s economic performance is dependent on a multitude of factors. We’re very closely linked to growth in the U.S., and new international developments, such as the recent CETA deal, may also contribute to a sunnier future outlook. The takeaway—the prognosis may be dour now, but it isn’t permanent.
Pro: You Can Always Flip To Fixed: A great feature of variable rates is their low commitment level. Should the Prime rate heat up unexpectedly, or should fixed rates suddenly take a dramatic tumble, variable borrowers can lock into the fixed term counterpart of their current rate.
© 2013 Real Estate Weekly