Should I Get a Variable or Fixed Mortgage? RBC Cuts Rates and the Answer is No Longer Clear

Last week, Canada’s biggest bank, RBC, cut its five-year fixed rate by 15 basis points. This gave customers the option to lock in their mortgage rate at 3.74 per cent, for a five-year term. And surely enough, TD Bank and BMO Bank of Montreal followed suit and cut their five-year fixed rates to the same level. Currently, CIBC is asking all customers to call in for more details on its five-year fixed rate, and Scotiabank is not showing the same 15-basis-point cut.

The move by some of Canada’s commercial banks is overdue. Unlike variable-rate loans that are affected by the Bank of Canada’s benchmark rate, fixed rates are tied to the bond market, and bond yields have been sinking over the last two months.

The yield for the Government of Canada benchmark five-year bond fell from a high of 2.48 per cent last October to a low of 1.76 per cent on January 3. At the time of writing this article, the bond yield has recovered slightly but still remains lower than two per cent. This means it’s cheaper for commercial banks to borrow money at a fixed rate and, therefore, they can pass down those interest rate savings to their mortgage customers.

So does this mean I should get a fixed-rate mortgage if I’m in the market?

The BoC is hinting at raising rates in 2019, and one rate hike could mean your variable rate mortgage would become even more expensive to service. With that being said, for the first time in many years, Canadian mortgage seekers are faced with a unique challenge.

Previously, going variable often meant saving money over the long term. Those who had the stomach to handle fluctuating interest rates were the perfect candidates for a variable rate mortgage. And those who wanted a stable, predictable monthly payment went with the five-year fixed mortgage.

But the recent fixed-rate cut has subsequently closed the gap between variable- and fixed-rate mortgages. For example, RBC is offering a variable rate of prime (currently at 3.95 per percent) minus 0.4 per cent. Meaning if you signed up today, you could get a variable rate at 3.55 per cent – that is only 19 basis points lower than the fixed rate.

So what’s a new home buyer to do?

Before choosing a variable or fixed mortgage, new home buyers and those renewing their mortgage term need to ask themselves, can I afford this mortgage loan if rates were two to three percentage points higher?

Depending on how long you’ve been an active member in the real estate market, you may remember a time when the prime rate at commercial banks was as high as 6.25 per cent (July 2007), and that was considered normal. But since the financial crisis, rates have hit record lows.

It is a possibility that variable rates could get that high again if the Bank decides to start raising rates aggressively. Canada’s economy is now ready for higher rates as we are operating at full capacity, unemployment continues to hang near a 40-year low, and business sentiment is high.

Bank of Canada has its concerns, but that won’t stop the rate hikes

The BoC says it is closely monitoring household debt and how rising interest will negatively affect those who have borrowed to their budget’s capacity. But despite household debt, global trade tensions and the drop in oil prices, the BoC remains focused on higher rates.

At the last interest rate announcement, rates were held at 1.75 per cent, but the Bank stated “Weighing all of these factors, Governing Council continues to judge that the policy interest rate will need to rise over time into a neutral range to achieve the inflation target. The appropriate pace of rate increases will depend on how the outlook evolves, with a particular focus on developments in oil markets, the Canadian housing market, and global trade policy.”

Canadians need to take advantage of lower interest rates before it’s too late, by proactively making lump-sum payments and accelerating their regular payments. If I was in the market for a mortgage today, I would strongly consider locking in the special fixed rates being offered by banks, since it seems variable rates will surpass fixed rates over the next five years.

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