As interest rates climb, how should you choose a mortgage?

The central bank raised its benchmark interest rate to 0.50 percent in March 2022, up from a record low of 0.25 percent. It is the first-rate increase since 2018. The hike will have an impact on the cost of borrowing for a variety of loans, including mortgages.

According to Mortgage Professionals of Canada research, about three-quarters of mortgages were fixed in 2020, indicating that many Canadians prefer the financial consistency that comes with a locked-in rate.

Nevertheless, variable-rate mortgages are still extremely popular, accounting for around 40% of all new loans in the second quarter of last year, according to a Canada Mortgage and Housing Corp. analysis, owing to the substantial discount between fixed and variable rates.

HOW ARE MORTGAGE RATES ESTIMATED?

First and foremost, educate yourself with the many types of mortgages accessible to you.

A fixed-rate mortgage provides homeowners with a consistent interest rate for a specified duration, which is often established in three-to-five-year intervals during the life of the mortgage.

The rates aren’t directly influenced by the Bank of Canada’s interest rate changes — even if anticipated rises can be built into the rate you’re provided — and so provide a bit more consistency in your monthly payments during the period.

Variable-rate mortgages are affected by Bank of Canada interest rate decisions since financial institutions tie their prime rates to the central bank’s benchmark rate. On top of that, you’d get a discount.

According to Leah Zlatkin, mortgage broker and specialist, today’s variable-rate mortgage contract may provide you the prime rate of 3.2 percent minus 0.6 percent.

FIXED VS. VARIABLE

Variable rates are usually lower than fixed rates, according to Zlatkin.

The main component in determining how these two rate types may affect monthly payment schemes is the “spread” between them.

Currently, Zlatkin estimates that the average variable-rate mortgage is between 2.3 and 2.6 percent, while fixed-rate mortgages are approximately 3.89 percent. The spread is therefore around 1.6%.

As the Bank of Canada raises interest rates, this disparity will likely to narrow. Bank prime rates will climb, reducing the gap between today’s fixed-rate amounts and variable-rate payments in the future.

HOW HIGH WILL RATES GO?

Tiff Macklem, Governor of the Bank of Canada, has made it clear that the institution will be “forceful” in raising interest rates in order to combat rising inflation.

Last month, the central bank raised its main overnight rate by 50 basis points to 1.0 percent. When the Fed announces its next rate hike in June, some analysts predict another half-point increase.

“Everyone has an opinion on where they believe rates will go, and nobody knows for sure unless you’re in the Bank of Canada, in which case you’re probably not telling anyone,” Zlatkin adds.

Desjardins stated in a mortgage rate estimate last week that the central bank will “quickly increase the key rate” in the next year, although it will remain below 2.5%.

The Bank of Canada had previously stated that it believes the “neutral rate” — the point at which interest rates are neither fueling nor impeding the country’s economic development — is between 2.0% and 3.0%.

IS IT TIME TO COMMIT TO A FIXED-RATE MORTGAGE?

According to Jimmy Jean, chief economist at Desjardins, the Bank of Canada’s intentions to swiftly boost interest rates might put a stop to the popularity of variable-rate mortgages after years of rock-bottom rates affected by the global economy.

“We’ve noticed a lot of interest in variable-rate mortgages.” But the farther we travel, the narrower that spread will become. “It could make sense in this environment to lock in interest rates that we can receive right now,” he adds.

Even with additional rate rises on the horizon, Sung Lee, mortgage agent with Rates.ca, tells Global News that there is still a “compelling argument” to go with a variable mortgage in the short term. He claims a 150-basis-point difference between most variable offers and the current fixed rate.

Though she warns that she does not have a “crystal ball,” Zlatkin predicts a 0.75 percent rise in the central bank’s overnight rate by the end of 2022. As a result, she believes variable rates will continue to be the less expensive choice in the long run. However, she points out that for more risk-averse market watchers, the bottom line isn’t the most important factor.

“it’s not worth it If you’re the type of person who is going to have a heart attack every time the Bank of Canada makes a announcement” she adds. “Just spend a few hundred dollars more and get a fixed rate.”

WHY YOU MIGHT NOT BE ABLE TO GET AS BIG A LOAN AS YOU THINK

With mortgage rates on the increase, there’s another issue to consider, and it might affect how much property you can buy.

Prospective purchasers, as well as those wishing to refinance an existing mortgage, must pass the mortgage stress test at the higher of two rates: the rate on offer plus 2% or the qualifying rate of 5.25 percent.

While people seeking pre-approval for a mortgage in recent years may have been used to qualifying at the 5.25 percent mark, today’s increasing rate environment may force them to take on mortgages with rates as high as 3.5 percent.

With the two percent increase, those purchasers can now qualify for mortgages with interest rates of 5.5 percent or more. According to Zlatkin, a couple that might have gotten a $500,000 mortgage three months ago could only be able to get roughly $473,000 now.

Rising interest rates are already having a cooling effect on Canada’s housing market, with sales beginning to “moderate” in most regions and prices in provinces like Quebec and Ontario perhaps having peaked.