If you’ve so much as glanced at a newspaper recently, you are likely aware of interest rate increases. The Bank of Canada (BoC) is making big waves by raising interest rates back to their pre-pandemic neutral levels. 

Simply put, the record low interest rates of 2020 and 2021 were only meant to be temporary. This was an emergency action taken by the BoC to safeguard the Canadian economy in a time of crisis.

However, the low rates caused inflation to rise, and now the Central Bank is taking aggressive action to remove its emergency supports and hike the interest rates back to the “normal” level. 

But what does this mean for the average Canadian? 

In a nutshell, interest rate increases should have a slightly cooling effect on the housing market. We should see moderating home prices, but at the same time, mortgage rates will also go up. 

Many Canadians who are applying for their first mortgage or renewing their existing loan are wondering if a fixed rate mortgage or a variable rate mortgage is best in today’s climate. 

We spoke with Andrew Thake, an Ottawa-based mortgage broker with over 15 years in the industry to tell us a bit more about what we can expect.

But first, let’s recap some mortgage basics:

What is a Fixed Rate Mortgage? 

A fixed rate mortgage is a mortgage product where the interest rate stays the same for the duration of the mortgage term. These rates are closely tied to the Canadian bond market rather than the Bank of Canada’s Policy Rate. 

The main benefit of a fixed-rate mortgage is stability. You will always know how much you are paying and you don’t need to worry as much about market fluctuations impacting your mortgage payments. 

Fixed rate mortgages are ideal for someone who is more averse to risk, and who wants to know exactly how much to budget each month. 

The downside of a fixed rate mortgage is that the rate you are locked into is often higher than a variable rate. The stability comes at an added cost. 

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Are you thinking about making a home purchase this year? Check out some of these resources to help you get started:

• New Construction Vs. Resale Home
• Condominium Vs. Freehold
• 6 Advantages of Older Homes
• 6 Advantages of Buying a Home with an Ottawa Real Estate Agent

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What is a Variable Rate Mortgage? 

A variable rate mortgage goes up and down with Canada’s Prime Rate, which is impacted by many factors including the BoC Policy Rate. This means your payment could fluctuate over the term of your mortgage. 

Historically, variable rate mortgages have been more beneficial for Canadians since the rates are often considerably lower than fixed rates. In many cases, homeowners with variable rates tend to pay off their mortgages faster and pay less in interest. 

However, the downside to a variable rate is the risk. It’s almost like investing in the stock market. You can’t predict what will happen, so you need to be prepared for rates to go up or down. “It’s a long-term strategy and it’s all about averages,” says Andrew.

Depending on your lender, you could choose a variable rate mortgage that either updates your payment based on the Prime Rate (fluctuating payment), or you could choose a variable rate mortgage that amends your principal/interest ratio on your payment to reflect changes in interest rates (fixed payment). With these types of variable mortgages, your payment stays the same, but your amortization period changes. 

Andrew Thake compares fixed rate vs. variable rate mortgages to investing in the stock market vs. investing in a GIC or Canada Savings Bond. The former plays on the idea of taking on more risk for a bigger return, while the latter won’t give a lot of return, but will come with more stability. 

Fixed Rate Vs. Variable Rate: Which is Better?

According to Andrew, “Choosing a fixed rate vs. variable rate is like choosing to buy a pickup truck vs. a convertible. They are entirely different products.” 

He says the right decision is based on a lot of factors, but primarily it relies on the individual client’s risk tolerance, which is different for everyone. 

“I coach my clients on the pros and cons of both,” says Andrew. “There is no way to say with absolute certainty what someone should do. We can’t predict if rates are going to go up or down, so if a client feels like they want a lower rate and the risk that goes along with that rate rising, then that is the best choice for them. Some clients are ok with paying a premium for the security of knowing their interest rates won’t change for the duration of their term.”

“There’s a bit more insurance built into a fixed rate,” he says. 

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What About the Mortgage Benchmark Stress Test? 

The mortgage stress test is a relatively new process that was implemented in an effort to help Canadians safeguard themselves against rising interest rates. Essentially, it works like this: when you get pre-approved for a mortgage, you actually need to get pre-approved at a higher rate. There are two options:

• You need to qualify for a mortgage using a rate of 5.25%
• Or you need to qualify for your true rate plus 2%, whichever is higher

Canada has some of the strongest mortgage lending rules in the world and the stress test is just another example of that. 

Andrew recommends that homebuyers consider the mortgage stress test when weighing the options between fixed vs. variable.

For example, variable rates can be pre-approved at a lower rate, which means you can get qualified for a higher loan amount and, therefore, a higher value home. Fixed rate pre-approvals are at a higher rate, which means your borrowing power is less and your options for homes might be slimmer. 

When rates were at 1% or 2% in the past couple of years, Andrew says most mortgages were qualified at the 5.25% benchmark. However, now that rates are increasing, it’s more common to see pre-approvals qualifying in the 7% range. 

Can You Switch From a Variable Rate to a Fixed Rate?

According to Andrew, most lenders will allow you to convert from a variable rate mortgage to a fixed rate without paying a penalty. It’s a bit of an escape plan if you are starting to get nervous about rising interest rates in your variable mortgage. 

However, it’s important to note that fixed rates are typically higher than variable. So if you convert from one to the other, you will most likely be locking yourself at a higher rate regardless. 

“Ask yourself if you would lose any sleep if your payment went up by a couple of hundred dollars per month,” Andrew suggests.

Real Advice From a Mortgage Broker 

With his experience in the market, Andrew has seen his fair share of interest rate hikes and drops. His advice is to always educate yourself and learn as much as possible before committing to a mortgage. 

“Is there anything happening in the market to suggest rates will go up?” he says. “There’s so much going on in the world with inflation, world events, and the stock market, it’s hard to predict where things will go.”

Andrew says the recent 1% increase to the Policy Rate will absolutely raise mortgage payments for those with a variable rate fluctuating payment mortgage and decrease the pre-approval amounts, effectively reducing purchasing power. 

“Some people are worried that things are going back to the 80s and 90s when interest rates were in the double digits,” he says. But it’s important to note that interest rates are still historically low and they are only going back to pre-pandemic levels.

“My biggest piece of advice is to lock in a fixed interest rate at the pre-approval stage. Rates can be held for up to 4 months so if you’re thinking about buying soon or renewing, it’s a good idea to lock in your rate before it goes up,” says Andrew. 

Are you ready to buy a home in Ottawa this year? We have the experience and skill to help you navigate a shifting real estate market. Contact us today here or set up your very own custom property search here.