Great insight on fixed vs variable mortgages in today’s interest environment by our friends at EQBank!
Spring has arrived and we’re starting to get a better sense of the real estate market in Canada this year. Sales and listings have been on the decline, but we’re still seeing small price increases in parts of the country. This isn’t a huge surprise since sales are typically slow during the winter so we may see some movement in the near future.
Recognizing that affordability is still an issue for many first-time home buyers, the federal government proposed a $1.25-billion incentive program that would help finance five to ten per cent of a prospective buyer’s mortgage as part of a shared equity program as long as they have a minimum down payment for the home purchase. They also plan to increase the amount that first-time buyers can withdraw from their RRSPs, from $25,000 to $35,000, per individual.
This news may help new buyers, but there are many other factors that all potential buyers need to consider when they start looking for a home.
Fixed vs Variable rate mortgages
Studies going back to 1950 show that, in general, borrowers tend to save money when they choose a variable rate mortgage instead of a fixed rate mortgage. A five-year fixed rate mortgage – by far the most common mortgage term in Canada – typically comes with a higher interest rate than variable rate mortgages or shorter term fixed rate mortgages.
Fixed rate borrowers pay a premium for predictability, knowing their mortgage payments won’t be upset when the Bank of Canada hikes interest rates.
Variable or floating rate borrowers, on the other hand, will see their rates rise and fall whenever the prime rate moves. These borrowers are betting that interest rates won’t rise above the current fixed rate, or that rates rise much later in the mortgage term when they’ve already made significant savings on the spread.
The variable mortgage argument has been less compelling lately as the spread between fixed and variable rates narrows.
Take Equitable Bank’s current 5-year adjustable rate mortgage of 2.95% versus its 5-year fixed mortgage rate of 3.14%. The spread is just 19 basis points and so all it takes is the Bank of Canada to increase rates by 1/4 of a percent for variable rate borrowers to see their rate surpass the fixed rate.
A good rule of thumb to follow is when the spread between fixed and variable rates is less than 50 basis points, go ahead and lock-in the fixed rate. When the spread is closer to 75 or 100 basis points, the variable rate is more attractive.