Your Options if You Have a Variable Interest Rate
There is no disguising that after 2 years of historically low interest rates due to the pandemic, rates are now on the rise in an attempt to reduce inflationary pressure.
At this time, we have already seen an increase of 1.25% to the overnight lending rate this year taking it to 1.50% currently, which further increases anticipated. To put this into context, the overnight lending rate pre-pandemic was at 1.75% so the Bank of Canada will most likely aim to get us back to these pre-pandemic levels by the end of the year at least.
Now I've written in the past explaining the benefits of going with a variable interest rate and why it may be the best option for you, but even with this in mind it can still be very difficult to continue believing this to be the right decision when you see your interest rate - and potentially your payment therefore - going up as aggressively as it has been lately.
That's where an understanding of the history of mortgage rates can help you put things into context and help see things from a bigger picture. Below is a graph comparing the average 5 year fixed rate against the prime lending rate, which the variable is connected to:
What you'll notice is that not since the early 90's has the prime rate been comparable to the 5 year fixed rate, and up to this point it has been the lower interest rate between the two. Between 1975 - 1990 there have been a few moments where the prime rate was actually higher, but that was always short lived and quickly readjusted below the 5 year fixed.
With this information in hand, we can assess the following options available to us with our variable interest rate.
Option #1 - Be patient and continue riding the variable wave
With an understanding that rates go up, and they also come down with the variable.
Continue saving and investing, and when your mortgage is up for renewal in about 5 years, drop any savings you have on the balance so you can feel good knowing you’re starting your new term with a much smaller balance if rates are higher at the time you go to renew.
Option #2 - Keep the variable, and pretend that you took the fixed rate
By increasing your payment voluntarily to the fixed rate option you continue to benefit from the lower interest rate savings (compared to the fixed rate) and instead of that extra payment going towards interest it’s going straight to principal.
Also by manually adjusting your payment on your own, you can get ahead of increased interest costs and remove the sticker shock of seeing your payment jump up.
Option #3 - Consider switching your variable rate to a bank who can offer a static payment
Many don't know that there are two different types of variable rates, one that changes your payment and one of that provides you a static/fixed payment and instead adjusts your amortization when rates adjust.
If one of our biggest concerns is payment affordability, you may want to consider a mortgage lender who offers a static/fixed payment with their variable rate. This would help with your budgeting so you can ride the wave easier not having to worry about your payment ever changing during the term.
Option #4 - Use your conversion clause
Your variable rate will have an ability to switch into a fixed rate at any point during the term of your mortgage.
It's very important you discuss the pro's and con's of this option with your mortgage broker before pulling the trigger on this option.
Right now, there is a large gap between the two rates, with the fixed rate being about 2% higher on average so you would be looking at a locking yourself into a much higher payment and penalty if you ever decide to break the mortgage early.
If the fixed payment is still affordable, it may be worth using the strategy in option #2 first, or at least until the two rates are more comparable.
Have questions on your variable interest rate? Schedule a call with us today to see how we can help.