Until last week, the Bank of Canada was firm on their stance in maintaining their overnight rate until sometime in 2023. They have since shifted their position and are now planning to increase their rate in the second half of 2022. The reason is due to our economy performing significantly better than their original predictions. If it continues along this new, improved pace, then their new projection is exactly what we can expect. Just as with leading economists, all they can do is speculate based on the information available to them as of today. One thing that’s becoming more clear is that the next move from the Bank of Canada will be up. It’s just a matter of when.

 

Will The Bank of Canada Change Their Position Again?
The deciding factor on the timing of the next rate increase will be the state of the economy. If it exceeds their revised projection, then they could increase their rate even sooner than the second half of 2022. This is not likely, but anything can happen.

Who would have thought that the economy would be this resilient to the pandemic?  The Bank of Canada certainly didn’t. Nor did leading economists. Nor did I.

There is still much uncertainty surrounding the economy and the pandemic. The economic impact from the current lockdowns are yet to be determined. Not just domestically, but globally. There is nothing to say that our current lockdown in Ontario won’t be extended further. Let’s hope this isn’t the case. Regardless, if the lockdown starts to negatively effect the economy, then this will slow its recovery, which may result in the Bank of Canada reverting back to their original stance of holding rates until 2023. As more people become vaccinated, COVID numbers should start to fall back under control.  Businesses will re-open, and the economy is expected to thrive. I’d like to think that we’re getting closer to this point, which makes it less likely that the BOC will revert back to their original position.

 

Are Fixed Mortgage Rates Now The Better Option?
The media will always make it sound like the sky is falling. They love to embellish and blow things out of proportion. After all, this is what gets attention and builds ratings. Riding the media wave, I’ve heard some mortgage professionals advising their clients to choose a fixed rate in response to the BOC’s new projection. I see this as a panic reaction. There is no need to make such an abrupt change of position. Even worse, to put it out as a blanket statement. I’m not saying that everyone should still be going with a variable rate mortgage. But I don’t think everyone should be going fixed either.

The change in the Bank of Canada’s position is definitely something that needs to be taken into consideration when choosing fixed vs variable. It’s noteworthy, and for some, it will be enough to choose a fixed rate over variable.  But there are other things to consider as I explain in my blog on The Ultimate Guide To Fixed Vs Variable.

Before making any snap judgements, the first thing we should do is take a closer look at what the change actually means. They were originally predicting that they would be increasing their rate at some point in 2023. ‘Some point’ is pretty vague. This could have meant January for all we knew. Now they are saying in the second half of 2022. Similarly, this could mean an increase in July or it could mean in December. The new projection may put the increase only a couple months ahead of their original prediction. We really don’t know for sure.

What we do know is that there is still a healthy spread between fixed and variable rates, which gives variable rate seekers added protection against rising interest rates. The spread between fixed and variable currently ranges between 0.60% and 0.80%, depending on your situation.  This is the largest spread we have seen since early 2019.

 

 

The Impact Of The BOC Decision On Variable Rate Performance

Let’s take a deeper look at how future increases from the Bank of Canada will affect variable rate mortgages. In this example, we’ll use a mortgage amount of $650,000 with a 25 year amortization. Our options are a 5 year fixed at 1.84% or a variable at 1.20%, which represents a spread of 0.64%.

As the Bank of Canada is now predicting they’ll increase their rate in the second half of 2022, we’ll set the first increase at one year, three months into the term.

 

Example 1 – Four Rate Increases
Beginning one year three months into the term, and then once every year thereafter.

Time of Increase      % Increase Rate      After Increase
1 year 3 months:                  +0.25%                             1.45%
2 years 3 months:                +0.25%                             1.70%
3 years 3 moths:                  +0.25%                             1.95%
4 years 3 months:                +0.25%                             2.20%

Rate at start of term: 1.20%
Rate at end of term: 2.20%
Original fixed rate option: 1.84%
Equivalent rate 1.6228%

Variable rate wins by $6,720.51

Four rate increases in the next five years is a likely scenario. In this example, you would have come out ahead by more than $6,700 by choosing the variable rate. This is despite the fixed rate climbing up above your original fixed rate option. This scenario would have been equivalent to having a fixed rate mortgage at 1.6228%, which is lower than the original 1.84% option. Variable rate is the clear winner in this case.

 

Example 2 – Six Rate Increases
Beginning at one year three months, each year for the next two years, then every six months until the end of your term.

Time of Increase      % Increase Rate      After Increase
1 year 3 months:                     +0.25%                          1.45%
2 years 3 months:                  +0.25%                           1.70%
3 years 3 months:                  +0.25%                           1.95%
3 years 9 months:                  +0.25%                           2.20%
4 years 3 months:                  +0.25%                           2.45%
4 years 9 months;                  +0.25%                           2.70%

Rate at start of term: 1.20%
Rate at end of term: 2.70%
Original fixed rate option: 1.84%
Equivalent fixed rate: 1.6896%

Variable rate wins by $4,658.81

Six rate increases along the way is not as likely, but not impossible. If the economy continues to exceed analyst’s expectations over the next five years, then this is a possibility, but not what I would call a probability. Even with a rate increase from the Bank of Canada coming sooner than originally expected, your variable rate savings are front end heavy. This means your variable rate was lower than the original fixed rate alternative for the front half of the term. The variable rate didn’t surpass the fixed rate option until two years three months into the term.

That gave you a pretty big head start over the fixed!

Even with more rate increases coming in the second half of the term, and occurring more frequently, you still would have come out ahead by more than $4,600 over the term. This is assuming no decreases along the way. There is nothing to say that we won’t see it fall back down after a few increases, which would be a more likely scenario.

 

Example 3 – Eight Rate Increases
Beginning at one year three months, and then increasing every six months thereafter.

Time of Increase      % Increase Rate      After Increase
1 year 3 months:                     +0.25%                            1.45%
1 year 9 months:                     +0.25%                            1.70%
2 years 3 months:                   +0.25%                            1.95%
2 years 9 months:                   +0.25%                            2.20%
3 years 3 months:                   +0.25%                            2.45%
3 years 9 months:                   +0.25%                            2.70%
4 years 3 months:                   +0.25%                            2.95%
4 years 9 months;                   +0.25%                            3.20%

Rate at start of term: 1.20%
Rate at end of term: 3.20%
Original fixed rate option: 1.84%
Equivalent fixed rate: 1.9482%

Fixed rates wins by $3,371.65

A scenario with eight rate increases without seeing a single decrease is even less likely. In this example, you would have come out ahead by almost $3,400 had you have chosen the original fixed rate option at 1.84%. In this situation, it works out to being equal to having a fixed rate at approximately 1.95% for the 5 year term. While 1.95% can sound high to some, it’s important to remember that we never saw 5 year fixed rates below 2% until summer of 2020. Prior to this, the lowest 5 year fixed rate offered in history was 2.14%. Historically speaking, 1.95% is a phenomenal rate! And this is with a whopping eight rate increases without a single rate drop along the way. As mentioned, this is not a likely scenario however.

What Happens If The BOC Increases Rates Even Sooner?
The new projections from the Bank of Canada are based on the economy continuing its resilience to the pandemic. Should it continue along the current trend, we can expect them to come through with an increase in the later half of 2022, as explained above. But what if it exceeds the current projections again and they decide to move up their increase yet again?

Let’s run the same scenarios but we’ll start the increases even earlier… just in case.

 

Example 4 – Four Rate Increases
Beginning one year into your term, and then once every year thereafter

Time of Increase      % Increase Rate      After Increase
1 year:                                      +0.25%                            1.45%
2 years:                                    +0.25%                            1.70%
3 years:                                     +0.25%                           1.95%
4 years:                                    +0.25%                            2.20%

Rate at start of term: 1.20%
Rate at end of term: 2.20%
Original fixed rate option: 1.84%
Equivalent rate: 1.6724%

Variable rate wins by $5,189.96

In what I believe to be the most likely of all the scenarios (four rate increases), you’d come out ahead by almost $5,200 by choosing a variable rate mortgage. This would have been equivalent to a fixed rate of roughly 1.67%. Variable wins.

 

Example 5 – Six Rate Increases
Beginning one year into your term, then again each year for the next two years, followed by every six months for the remainder of the term.

Time of Increase      % Increase Rate      After Increase
1 year                                         +0.25%                          1.45%
2 years:                                      +0.25%                          1.70%
3 years:                                      +0.25%                          1.95%
3 years 6 months:                    +0.25%                          2.20%
4 years:                                      +0.25%                          2.45%
4 years 6 months;                    +0.25%                          2.70%

Rate at start of term: 1.20%
Rate at end of term: 2.70%
Original fixed rate option: 1.84%
Equivalent fixed rate: 1.7621%

Variable rate wins by $2,418.62

Even with six rate increases beginning earlier than expected, you’re still coming out ahead by more than $2,400 with a variable rate mortgage. This would have been equivalent to having a fixed rate at roughly 1.76%.

 

Example 6 – Eight Rate Increases
Beginning at 1 year three months, and then increasing every six months thereafter.

Time of Increase      % Increase Rate      After Increase
1 year 3 months:                      +0.25%                         1.45%
1 year 9 months:                      +0.25%                         1.70%
2 years 3 months:                    +0.25%                         1.95%
2 years 9 months:                    +0.25%                         2.20%
3 years 3 months:                    +0.25%                         2.45%
3 years 9 months:                    +0.25%                         2.70%
4 years 3 months:                    +0.25%                         2.95%
4 years 9 months;                    +0.25%                         3.20%

Rate at start of term: 1.20%
Rate at end of term: 3.20%
Original fixed rate option: 1.84%
Equivalent fixed rate: 2.0461%

Fixed rates wins by $6,440.86

Should this situation play out, the fixed rate would have been the clear winner from the get go. You would have been ahead by almost $6,500, which is a pretty large margin in anyone’s books. This would have been equivalent to having a fixed rate of roughly 2.05%. As mentioned above, this still one of the lowest fixed rate mortgages in history, one that was never seen before summer of 2020. That still doesn’t remove the sting, but it’s a much more positive thought than focusing on the $6,500 you would have been ahead if you had chosen the fixed rate mortgage to begin with.

 

My Final Thoughts On Fixed Vs. Variable

As I’ve always stated, there is no one size fits all mortgage advice and everyone is a bit different. What’s right for one person might not be right for the next. When your friend, neighbour, parent, cousin, brother, sister, or colleague suggests for you to go fixed or variable, remember that he/she is coming to you from their own thoughts, feelings, financial situation, and tolerance for risk. This doesn’t mean that you’ll fit into the same box. Everyone can be a bit different, and I’ll always tailor my mortgage advice accordingly. I may recommend for one client to choose a fixed rate, but then advise the very next client I speak with to go variable.

We’re all unique in our own way. The best choice is not always the one that saves you the most money. It’s the one that allows you to sleep soundly at night. For many, it doesn’t matter how much they would have come out ahead if they chose a variable rate. If the fixed rate gives them a solid peace of mind throughout their term, then that alone can make it the perfect decision.  Each and every time, regardless of what happens with rates.

For more information on making the right choice between fixed and variable, check out my blogs on Everything You Need To Know About Variable Rate Mortgages and The Ultimate Guide To Choosing Fixed Vs. Variable

For the ultimate resource, you may want to pick up a copy of my Amazon #1 best selling book ‘Beat The Bank – How To Win The Mortgage Game in Canada’.  100% of the proceeds are donated to the Canadian Alliance to End Homelessness.

 

Please leave any questions or comments below. I’d love to hear from you!