Variable rate mortgages have historically outperformed fixed rates most of the time. But that doesn’t mean they always win. If they did, then no one would even consider a fixed rate mortgage. Yet history has shown fixed to be the more popular choice.

Why?

People like fixed rate mortgages as it gives them peace of mind in knowing that their rate and payment will not change over the term. For some, the mere thought of a rate increase on a variable rate product is enough for them to become fraught with anxiety. With a variable rate mortgage, there are no guarantees, and anything can happen.

And there is a very big difference between variable rate mortgages today vs. in the past.

While there are five things to consider before choosing a variable rate mortgage, there are two that we need to focus on today.

The first is the spread between fixed and variable. The second is the market outlook.

 

Spread Between Fixed and Variable

Yes, it’s true that in the past, variable as beat out fixed most of the time. But in the past, variable rate mortgages have generally started out lower than the fixed rate options. Regardless of what happens over the next five years, you’re starting out in a winning position as your savings build starting with your very first payment. The larger the spread, the bigger your savings and the more protection you have against rising rates. Fixed rates came at a rate premium, which many felt comfortable paying to have the peace of mind that comes with a rate and payment locked in for the term.

But that isn’t the case with today’s variable rate mortgages.

While fixed rate mortgages used to be the ones with the premium, it’s now the other way around. In fact, variable rate mortgages are now priced more than 1.00% higher than the fixed rates options in most cases.

This means that you’re starting out in a losing position from the beginning.

Even if the variable rate falls below the fixed rate during the term, that doesn’t mean that variable was the right choice. Sure, the rate would then be lower, but now you must make up the lost ground. By starting with a rate that is more than 1.00% higher than the fixed, you’re digging a pretty deep hole…and digging it fast.

 

Market Outlook

The only reason why some considering variable rate mortgages today is because rates are expected to fall considerably over the next few years.

An upcoming recession is not just possible… it’s probable, if not certain.

The Bank of Canada’s primary objective is to bring inflation under control. Once they are convinced that the problem is behind them, they’ll then set their sights on restoring the economy. 

This is when we can expect them to start cutting their rate.

How much they cut will depend on how much economic stimulation will be required. The worse the recession, the deeper the cuts.

It was great news when the Bank of Canada stated that they were pausing rate hikes in their March 8th announcement. But they also said that they are still prepared to go higher if needed.

Pausing doesn’t mean they are over. It means that they are taking a ‘sit back and watch’ approach.

Another piece of good news from their March announcement was that they still expect to see inflation down to 3.00% by mid-2023…not too far away. That was their expectation on March 8th. We’ll find out if they make any changes in their next announcement on April 12th.

 

Rate Forecasts from the Big Six Banks

As of now, all six of the big banks are forecasting that the Bank of Canada will cut their rate by 1.00% to 2.00% in 2024. 

National Bank is predicting that the cuts will start in the fourth quarter of 2023 while the others believe they will start in the first quarter of 2024.

BMO is currently forecasting a 1.00% cut in 2024, and is the most pessimistic of the group. 

TD is the most optimistic, forecasting cuts of 2.00%. 

RBC, CIBC, National Bank and Scotiabank all believe that the BoC will cut their rate by 1.50% in 2024.

As we are very well aware based on what we experienced in 2022, forecasts can radically change. Either for the better or for the worse. It’s possible that we could see the Bank of Canada start to cut their rate earlier than expected. But it’s also possible that the cuts could be pushed out. Time will tell.

 

Shorter Term Fixed Rates

Given that rates are expected to fall, few people are choosing terms longer than three years. I did a detailed analysis of short term fixed rates in last week’s blog on How to Choose Between a 1, 2 or 3 Year Fixed Rate Mortgage. It should give you some valuable insight on choosing the right term in today’s market.

 

Variable Rate or Short Term Fixed?

Even with variable rate mortgages being significantly higher than fixed, it’s still possible that you could come out ahead. It comes down to four things:

When the BoC starts cutting their rate

The size of the cuts

The number of cuts

The frequency of the cuts

Not even the Bank of Canada knows what will happen… and if they don’t know, then how are you supposed to?

There is no way to know for sure and all we can is speculate.

 

A Side by Side Comparison of a Fixed and a Variable Rate Mortgage

I’ll try to make this easier for you by running through six possible scenarios illustrating the outcome based on potential future rate movement. The following information will be used for each one:

 

Mortgage amount:  $500,000

Amortization: 25 years

Payment frequency: Monthly

Fixed rate: 4.54%*

Variable rate: 5.60% (prime -1.10%)*

Spread: 1.06%

 

Scenario One

Prime rate drops by 1.50% in 2024 with no further changes

Time Until Rate Cut % Rate Change Variable Rate After Decrease
9 Months -0.50% 5.10%
1 Year -0.50% 4.60%
1 Year 3 Months -0.25% 4.35%
1 Year 6 Months -0.25% 4.10%

Winner:  Fixed by $1,733.66

Scenario Two

Same as above but with four more 0.25% rate cuts for a total of 2.50%

Time Until Rate Cut % Rate Change Variable Rate After Decrease
9 Months -0.50% 5.10%
1 Year -0.50% 4.60%
1 Year 3 Months -0.25% 4.35%
1 Year 6 Months -0.25% 4.10%
1 Year 9 Months -0.25% 3.85%
2 Years -0.25% 3.60%
2 Years 3 Months -0.25% 3.35%
2 Years 6 Months -0.25% 3.10%

 

Winner:  Variable by $2,411.98

Scenario Three

First rate cut in six months followed by four more over the next year for a total of 1.50%

Time Until Rate Cut % Rate Change Variable Rate After Decrease
6 Months -0.25% 5.35%
9 Months -0.50% 4.85%
1 Year -0.25% 4.60%
1 Year 3 Months -0.25% 4.35%
1 Year 6 Months -0.25% 4.10%

 

Winner:  Fixed by $1,067.80

Scenario Four 

First rate cut in one year followed by seven more for a total of 2.50%.

Time Until Decrease  % Rate Change Variable Rate After Increase
1 Year -0.50% 5.10%
1 Year 3 Months -0.25% 4.60%
1 Year 6 Months -0.25% 4.35%
1 Year 9 Months -0.25% 4.10%
2 Years -0.25% 3.85%
2 Years 3 Months -0.25% 3.60%
2 Years 6 Months -0.25% 3.35%

Winner: Fixed by $730.53

Scenario Five 

First rate cut after 1 year six months followed up by five more until the end of the term for a total of 2.00%.

Time Until Rate Cut % Rate Change Variable Rate After Decrease
1 Year 6 Months -0.50% 5.10%
1 Year 9 Months -0.50% 4.60%
2 Years -0.25% 4.35%
2 Years 3 Months -0.25% 4.10%
2 Years 6 Months -0.25% 3.85%
2 Year 9 Months -0.25% 3.60%

 

Winner: Fixed rate by $6,625.38

Scenario Six 

First rate cut in three months followed by ten more until the end of the term for a total of 3.00%.

Time Until Rate Cut % Rate Change Variable Rate After Decrease
3 Months -0.25% 5.35%
6 Months -0.25% 5.10%
9 Months -0.50% 4.60%
1 Year -0.50% 4.10%
1 Year 3 Months -0.25% 3.85%
1 Year 6 Months -0.25% 3.60%
1 Year 9 Months -0.25% 3.35%
2 Years -0.25% 3.10%
2 Years 3 Months -0.25% 2.85%
2 Years 6 Months -0.25% 2.60%
2 Years 9 Months -0.25% 2.35%

 

Winner:  Variable rate by $9,210.33

 

This should help to give you a better understanding on the effect of downward rate movement in different situations. These are not predictions, just possible scenarios. I’ve added in at least one oversize rate cut in each one and have not included any potential increases.

Regardless of whether the Bank of Canada is more aggressive or less aggressive over the next few years, the above should still be helpful in determining where you would stand with a variable rate.

As you can see, it’s largely dependent on when the cuts start. The sooner they start, the greater chances of coming out ahead. If they get pushed out, then the odds of winning with variable diminish substantially.

 

There Are No Guarantees

Regardless of whether you choose a fixed or variable rate, you’re taking a chance. But at least you have some certainty with fixed rates. 

It’s possible that you could come out ahead with variable. It’s also possible you could come out ahead playing blackjack at the casino. 

The odds of coming out one way or another can be compared with flipping a coin.

There are a few questions to ask yourself before making the final decision:

How would you feel if the rate decreases do not come as soon as expected?

How would you feel if the rates don’t dome down as much as you expected? 

How would you feel if the Bank of Canada INCREASED their rate further?

If your answer to any of these questions creates anxiety, then you’re probably better suited to a fixed rate mortgage. As I say in my book, the best choice isn’t always the one that saves you the most money. It’s the one that allows you to sleep soundly at night.

 

Conclusion

The choice between fixed and variable can be enough to bake your brain at times. It doesn’t matter how much you read, or how much you speculate. It’s easy to worry about making the wrong decision. It’s only human.

You can only decide based on the information you have today. Sure, you may look back in a couple of years thinking that you should have made the other choice. Always easy to do once you know the outcome. But for now, you can only go based on what you know today, and what you think will be best for you and your family. 

If you’re particularly worried about the future of rates, then go with a fixed rate. At least you know your rate and payment are guaranteed for the term. But if you’re willing to roll the dice, and are comfortable with all the uncertainty, then it’s possible that you could still come out ahead with a variable rate.

Time will tell and anything can happen.

 

*The 3 year fixed at 4.54% and variable at 5.60% (prime -1.10%) are available for certain situations only.  Rates can vary based on purchase price, down payment/equity percentage, property value, purchase date, usage of property, etc. Please contact us to find the lowest available rate for your situation.  You can read more this in my blog on Why Different People are Quoted Different Rates