Variable rate mortgages may offer savings for borrowers in current environment

Houses and townhouses are seen in an aerial view, in Langley, B.C., on Wednesday May 16, 2018. (THE CANADIAN PRESS/Darryl Dyck)

TORONTO -- Canada's big banks are locked in a competitive pricing war over variable-rate mortgages, but economic trends point to more interest rate hikes ahead -- leaving Canadian mortgage borrowers struggling to interpret the mixed messages.

The Bank of Canada has raised its trend-setting interest rate once this year and is expected to do so at least once more before the end of 2018. When interest rates rise, banks are inundated with demand for fixed rates, so borrowers can lock in their rates.

As a result, Canada's lenders are working to attract borrowers to variable-mortgage rates, which are tied to the fluctuations of the central bank's overnight rate. They are offering special rates as low as 2.45 per cent for May, some of the biggest-ever widely advertised discounts advertised by the big banks. At the same time, they have increased the rates of their fixed-rate mortgages.

Even in this rising interest rate environment, experts suggest current variable-rate options are attractive when compared to fixed-rate mortgages.

"Up until recently, when asked, I had been favouring the fixed over the variable," said Dave Larock, president of Integrated Mortgage Planners Inc. in Toronto.

His attitude changed after fixed-rate mortgages became more expensive in response to higher bond yields and variable-rate mortgages got cheaper due to competition among lenders.

As a result, the gap between the available rates from the 15 lenders Larock consults widened to nearly one full percentage point, with the five-year variable rate at 2.45 per cent and five-year fixed rate at 3.39 per cent.

"That's your margin of safety," Larock said. "That's how far variable has to rise before you're paying more than the fixed rate."

Larock cautioned there are plenty of warnings that the Bank of Canada's influential overnight rate will be going up again this year -- a move that would quickly push up the cost of a variable-rate mortgage.

But he said it's debatable whether the central bank will act as quickly as economists anticipate, adding it's statistically unlikely that the overnight rate will go only upward over the next five years, given historical trends going back 28 years.

"Even if rates go up first, there's a very reasonable chance that at some point they'll drop (again)."

As a result, borrowers could very well end up paying less total mortgage interest over the next five years by choosing a variable rather than fixed rate, Larock said.

But some argue it's unwise to become too focused on securing the lowest available interest rate.

"You might actually not be doing what's right for you, given all of the things that are around the financial needs of you or your household," said Stephen Forbes, a CIBC executive vice-president whose role includes personal banking.

Forbes pointed to a client in Toronto who initially wanted to borrow $800,000 through a variable mortgage to help pay for a $1.6 million house.

"Her only focus was on rate. She wanted the lowest rate possible," Forbes recalled.

But the client changed her mind after taking a broader look at the situation, including her household income, non-mortgage debt, children's ages, and her and her husband's lifestyle aspirations.

The fixed-rate option provided her the certainty she wanted over knowing what her rate would be for the foreseeable future, he said.

In the end, Forbes said the client opted to borrow only $650,000 with a fixed-rate mortgage -- not variable -- and also consolidated non-house debts in line of credit at a lower rate.

There are times when a variable rate mortgage is the perfect decision for a borrower, Forbes said, but that depends on the individual's circumstance and their ability to cope if the variable-rate mortgage becomes more expensive.

"What I see sometimes that worries me is when people use a variable rate mortgage as a lever to borrowing more -- hoping that rates will not change down the road."

There are ways for people with variable-rate mortgages to protect themselves from a higher interest rate, Larock said.

Borrowers can structure their household budget to be able to pay the higher fixed-term rate for the next five years -- even if the variable mortgage's rate is lower, he said.

"Instead of just pocketing the extra cash ... plow that savings back into the mortgage to pay if off more quickly."