Published: Feb 13, 2023
How should you deal with your variable rate mortgage?
It’s no secret GTA homeowners who have a variable rate mortgage have had a miserable time of it this past year.
Historically, 25% to 30% of all new mortgages are variable. However, as recently as one year ago, far more people than usual were choosing variable, not fixed-rate mortgages. One lender told me recently their percentage was as high as 70% of all new business in Peel Region. Why was that?
- A typical fixed-rate mortgage was around 2.5% to 3%, while a variable-rate mortgage was really low at 1.25% or so. It was hard for people to ignore the lower rate.
- The Bank of Canada governor himself had assured us all in November 2020, “We want to be very clear,” he said. “Canadians can be confident that borrowing costs are going to remain very low for a very long time.”
- With some lenders, you could fix your payment based on the 1.25% rate, even though the rate may vary over the five-year term. This allowed homeowners to plan their household budgets based on a very low monthly mortgage payment.
Most variable-rate mortgages have these static monthly payments, which protect the borrower’s cash flow from changes to the Prime Rate. Four of the big six banks offer this, and so do several credit unions.
Even as the Bank of Canada began to raise their overnight rate starting in March 2022, the variable rate mortgage remained hot and attractive.
One reason was the mortgage stress test. Right up until the summer of 2022, you qualified for a larger mortgage if you chose a variable versus a fixed-rate mortgage. Local residents took on more payment risk in order to borrow more money!
No one foresaw nine Prime Rate increases on the horizon. Yet here we are, on July 12, 2023 with the banks’ Prime Rate at 7.20%, the highest level in 22 years.
Every day we field inquiries from variable rate mortgage holders trying to understand their options. And not all have the static payment variety – but have seen massive increases in their scheduled payments.
The top three questions people ask are:
Let’s take a closer look at these questions:
Should I convert my variable rate mortgage (VRM) to a fixed rate mortgage?
Switching is certainly a valid option. If you stay with your current lender, switching to a fixed-rate mortgage will not be penalized. You simply accept their most suitable offer of term and rate.
They may offer you a new full five years of term in a fixed rate mortgage, and you may also be offered a term as short as the remaining term on your VRM, depending on your lender’s policies.
If your mortgage has an adjustable payment which has increased with every single change to the Bank Prime Rate, yours has been by far the most miserable experience with a variable rate mortgage this past year.
When you convert, you will now enjoy a payment reduction, getting some cash flow relief.
On the other hand, if your VRM has a static payment, please understand your new fixed rate will almost certainly result in a higher payment than you have now. Perhaps quite significantly so, and more than if you had chosen to increase your VRM payment to get in front of your Trigger Rate.
Also, remember that your lender may not present you with sharp offers. After all, you are a captive audience because if you wish to leave, you will be looking at a prepayment penalty of three months’ interest. That is not chump change since your variable mortgage rate might now be around 6%. For example, that $800,000 mortgage could trigger a $12,000 prepayment penalty.
Should I change lenders and take a fixed-rate mortgage elsewhere?
This decision will often come down to basic arithmetic. First, is the best offer from another lender such that the accumulated savings from lower payments are materially greater than the prepayment penalty your current lender will charge you to leave them? Secondly, will moving your business to this new lender position yourself better for whatever decisions your future self may have to make?
The rates available can range quite significantly depending on how and when you got here. Your new mortgage may be classed as one of: an insured, insurable, or uninsurable transfer. We will get into the differences between these terms in a later article.
Do I make a lump sum payment, or do I increase my regular payment?
Some homeowners have accumulated decent savings and wonder if they should plunk this money into their mortgage. Surely that will get things sorted out, and then they can leave their VRM static payment mortgage intact?
The answer is no. You will be far better off by increasing your monthly payment and keeping your savings in reserve.
This week I ran the numbers for clients with an $800,000 balance owing on their VRM who are about to hit their Trigger Rate.
They asked me if taking their life savings of $40,000 and prepaying a chunk of their mortgage was the best thing to do. I asked them what they were trying to accomplish, and they said they wanted to avoid a payment increase no matter what.
Using our website’s Trigger Rate Calculator, I estimated their Trigger Rate would increase from 6.40% to 6.74%.
That’s not much at all.
If the Bank of Canada raises rates twice more by only 0.25%, these homeowners will again be in negative amortization territory. They will hit their new Trigger Rate pretty quickly.
But if instead, they increased their monthly payment from $4,270 to $4,500; then their Trigger Rate will go up to 7.11%
It is FAR BETTER to pay only $230 extra each month and keep most of the $40,000 intact and growing.
Remember, every situation is unique – your numbers will be different, but our point here remains the same.
Make sure you are talking to a mortgage broker who has a deep knowledge and experience with all things related to variable rate mortgages and the rules of transferring to another lender.
S/he will be able to source and explain the best mortgage for your circumstances from a wide array of lenders.