Over the past few years it seemed every expert was telling us that interest rates would be rising, and now after years of record low rates, the Bank of Canada (BoC) has started to raise them. The first increase was in July, the first in seven years from 0.5% to 0.75%, citing "bolstered" confidence that the Canadian economy has emerged from years of slow growth.
Canada's largest banks matched the central bank's move by raising their prime rates by a quarter-percentage-point to 2.95%. Prime rates influence the cost of borrowing on floating-rate loans, including variable-rate mortgages, credit lines and student loans. It's expected the BoC may continue to raise the prime rate incrementally over the next few months and into 2018. However, economic conditions change and so do outlooks and forecasts.
Fixed-rate mortgages are tied to bond prices and yields and currently they are fairly flat. There is some talk about the impact of risk-sharing going forward in the mortgage market, but for now, all quiet of that front.
So, here we at a crossroads again when getting a mortgage. Do you take the fixed rate or the variable rate? And once again, the answer -- it depends.
Many home buyers choose a fixed rate because they know exactly how much principal and interest they pay on each regular mortgage payment throughout the term. However, when interest rates go down, they can't take advantage of that to save money on interest. Variable rates continue to be popular among home buyers, with fixed rates gaining favour because they continue to be relatively low. At this writing, a five-year fixed rate varies from 2.89% to 3.09% while a variable rate ranges from 2.2% to 2.6%.
A study of mortgage data from 1950 to 2007 found that by choosing a variable rate mortgage, Canadians saved $20,000 in interest payments over 15 years, based on a $100,000 mortgage. At that time, homeowners were better off with a variable rate mortgage than a fixed rate mortgage 89% of the time.
In today's market variable and fixed rates do not look as if they'll be dropping. It is possible that rising interest rates are here to stay, but it's important to ask the question: Is it just a blip or a trend? Time will tell.
In the meantime, it might be prudent to prepare for rate increases this year and through 2018. Here are some suggestions:
- Lock in your mortgage. When prime rates start rise, variable-rate mortgage holders may be vulnerable. This is a personal decision and is based on your risk tolerance. At minimum, consult your mortgage broker to find out what works best for you.
- Don't commit to long-term GICs. It doesn't make sense to tie up your money for five years in an environment where rates are likely to rise. Speak to your investment counsellor.
- Stay short-term with bonds. When rates rise, bond prices go down. That doesn't mean stay away from bonds, just invest in the short-term. Again, speak to your investment counsellor.
We have been in an historically-low interest rate environment for eight years now -- it's looks as if it may change