As of 10 a.m. on April 13th, 2022, Bank of Canada announced its decision to increase the Overnight Rate by an unprecedented 0.50%. This brings the total increase in the current rate hike cycle to 0.75%. The immediate takeaway for those of you with a variable rate mortgage/ borrowing is that your interest costs continue to rise in the short term, but hopefully NOT for an extended period of time.
Depending on the kind of variable rate mortgage you have:
1. Your payment will increase as soon as the next scheduled payment date OR
2. The proportion of your interest costs will increase as compared to the principal being paid down with each payment (resulting in a longer amortization period).
Note: Prime Rate will increase to 3.20% at most lenders after this update (except for TD which should be at 3.35%). Review your lender/bank's commitment document to confirm which of the above payment scenario applies to your mortgage. Whichever be the case you would most likely be saving money as compared to signing up for a new or switching to a 5-year Fixed mortgage at current levels (more details below).
Even with this increase, the spread between fixed-rate and variable-rate mortgages remains about 1.50% or higher on average across the various types of mortgages.
Fixed Rate Mortgages
As you know the Fixed-rate mortgages in Canada are priced off the 5-year bond yields and those bond yields have witnessed a steep increase in the last 6 weeks. Since my last update, the yields have soared to 2.658% (on 10th April) from previous levels of 1.446% (on 3rd March 2022). Yields have risen by nearly 2.3% from the lows witnessed in July 2020 when they were at around 0.302%.
This has meant that the banks/lenders have been busy trying to adjust their price of Fixed rate mortgages upwards. The lowest 5-year fixed for a purchase with a 20% downpayment is now in the range of 3.50% to 3.80% OAC (higher from 2.59% reported last). While an insured mortgage (less than 20% downpayment) can be secured in the range of 3.00% to 3.50% OAC (up from 2.59% from the last update).
Given these significant increases, mortgage eligibility is lower when a borrower opts for a new Fixed Rate mortgage (as compared to Variable Rate mortgage) on purchase or transfer due to higher qualification rates.
Who should NOT consider a Variable Rate Mortgage?
Given the significant spread between Variable Rate & Fixed Rate Mortgage, I often get asked as to what should one opt for. Unfortunately, there is no one-size-fits-all answer to this question but if one or more of below applies to somebody then variable rate mortgage is most likely not a good fit for them:
Have a credit score below 650
Mortgage payment is/will be significant portion of monthly income (35% or higher) and have less than 10%~15% equity in their home
Have a conservative approach and cannot endure any fluctuation in payments/interest costs etc. Other clues are: Mostly park savings in GIC/cash/Bonds or cannot endure more than 20% decline in the value of equity/stock investments
If opting for a Fixed Rate mortgage right now, I will recommend considering shorter terms (1 to 3 year) and opting for Non-Big 5 bank mortgages. This is also advisable if planning to move/ sell existing home/ refinance or switch in the near future (average tenure of most mortgages is just 33 months!).
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