I bought my first house back in 2008 in Toronto by using my savings and with some help from the Home Buyer’s Plan, a Canadian government program which allowed me to withdraw $20,000 from my RRSPs, tax-free, to put toward the purchase of my first home.
The rest was financed with a five-year variable rate mortgage. At the time, my mortgage broker pointed out that over the last 20 years, going fixed had only paid off a handful of times. Variable rates are tied to the prime lending rate, which is driven by the key policy rate set by the Bank of Canada. I got an incredible rate as interest rates had come down considerably during the 2008 credit crisis.
Rates started to go up in 2010 and then stayed put for the next two years. When my mortgage came up for renewal in early 2013, fixed rates were still quite low and I figured interest rates would eventually start rising again — so I went for a 10-year fixed rate mortgage. The rate was higher than for a variable rate mortgage, but it was comforting to know my rate would stay the same for the next decade.
And then, I unexpectedly moved to Calgary.
I rented out my Toronto house rather than try to sell it, in case I decided against staying in Calgary long term, but after a couple years, I was ready to sell. I didn’t want to be a landlord anymore and was worried about a costly repair if something went wrong at my nearly 100-year old home. Even with a home equity line of credit (HELOC) to cover such outlays, I didn’t want to deal with contractors while halfway across the country.
When you own property that isn’t your principal residence, you’re also subject to capital gains tax on any gains you make after you stop living there. That meant that a good portion of any gains I made as Toronto housing prices continued to rise would be going to the CRA instead of me.
Selling was easy. Stomaching the penalties for closing out my 10-year fixed rate mortgage almost four years early was not — there was a comma in that price tag. Early termination or adjustments to a fixed rate mortgage often result in significant penalties, unlike variable rate mortgages, where mortgagors can make changes at any time.
Buying in Calgary
When it came time to buy a place in Calgary, I took solace in the fact that what I’d save on land transfer taxes, which we don’t have in Alberta, might just make up for my prepayment penalties. It took a while to find the right house, but interest rates were still quite low and were expected to stay low during the COVID-19 pandemic. I went with another five-year variable rate mortgage. With a larger down payment, I qualified for an uninsured mortgage. Insured rates apply if you’re buying with less than 20% down.
A lower down payment means the mortgage is a high-ratio loan, so lenders expect to be compensated for the higher probability of default. These mortgagors must pay mortgage default insurance premiums that are often referred to as CMHC (Canada Mortgage and Housing Corporation) premiums.
Rates on the rise
Fast forward to 2022, when the Bank of Canada announced its first rate increase since 2018. This got me thinking about my mortgage. Maybe I needed to make some adjustments, and I wanted to know my options. I contacted my mortgage broker, who advised that any renegotiation of my mortgage had to be done directly with the lender.
I met one of my lender’s mortgage specialists, who advised against moving to a fixed rate mortgage, as this would effectively move me to a higher rate sooner than if I let the Bank of Canada’s progressive rate hikes play out and trickle down to my variable mortgage rate. While mortgage rates don’t have to adjust in lockstep with changes in the prime rate, they typically do, usually within a +/-5 basis points (0.05%) differential.
When rates increase, some variable-rate mortgage holders will see their payment amount go up, but others may be able to maintain their payment amount, since the terms of some variable rate mortgages offer cap protection in the event of rising rates. Mortgagors simply end up repaying their principal more slowly as interest makes up a bigger portion of their payments.
Variable versus fixed
Why would anyone want to pay more interest sooner than they have to? Prime would have to increase from 2.7% (where it was at the time of writing in March 2022) to 4.3%, for me to pay the same as a five-year fixed rate mortgage would cost me today and 5.2% to match my quoted 10-year fixed rate. That 1.6% difference equals more than six 25 basis point rate increases from the Bank of Canada, before my rate and the five-year fixed rate would equalize.
For those wondering about a blend and extend arrangement, this isn’t an option with variable rate mortgages and not even on all fixed rate ones. The idea is to find a middle ground between the mortgagor’s fixed rate and prevailing fixed rates. There are no or reduced prepayment penalties, but you will incur administrative fees to renegotiate.
If rates are rising the worry is how much higher they could be at renewal, in which case it can be beneficial to blend and extend. Alternatively, mortgagors might want to take advantage of now-lower rates. Extend indicates that this restarts the mortgage term and blend refers to the new rate being a blend of the original mortgage rate and currently-offered fixed rates. Lenders will switch the terms of a mortgage in exchange for locking you in for longer.
Expectations of multiple rate increases are creating upward pressure on fixed mortgage rates, which are affected by bond market activity. From here, fixed rates could very well hinge on what the market fears more: inflation or mounting geopolitical concerns.
While mortgage brokers are independent, anyone who works for the lender is not, and they may have their employer’s bottom line more top of mind than yours. Figure out how much you stand to lose versus how much you could potentially save by renegotiating your terms and/or rate. Make sure to crunch the numbers yourself and compare to what the bank or lender gives you.
It’s also a good idea to do some research so you know what questions to ask and try to figure out all of the options available. A mortgage specialist can answer your questions correctly, without divulging there are better options. I’m very familiar with this material given I’ve spent my entire career in the financial services industry – yet I still had to ask some very pointed questions to get the information I wanted.
In fact, the mortgage specialist called me afterwards to say they’d misinformed me about my payments not going up. I asked three different ways about whether my payments would go up or not after prime went up, and was told each time that they would stay the same and push out my amortization period.
Up for renewal
People who need to renew now are rightly the most concerned since they are too close to qualify for a blend and extend because mortgages can only be renewed up to six months before their due date.
Less financially secure borrowers may want to consider a hybrid mortgage, in which the mortgage balance is split between variable and fixed. Or they can even go with a fixed rate mortgage – for the security that comes with knowing what their payments will be.
According to experts, homeowners should budget for at least 200 basis points of rate hikes, which would increase monthly payments by around $100 per $100,000 of mortgage.
That really drives home the importance of having an emergency fund to navigate changes like the sudden increase in household expenses.
In the end, I decided to sit tight with my current mortgage. My interest rate and payments will go up, but they’re not going up by a huge amount all at once like they would if I’d moved to a fixed rate mortgage – and they’re not going up today. I went with the recommendation from numerous mortgage brokers to delay making higher mortgage payments until the Bank of Canada actually takes rates higher.