Home buyers getting a new mortgage or homeowners with a mortgage coming up for renewal have a choice of choosing a fixed or variable rate, as well as the term of the mortgage.
Brokers and bankers will say a variable rate mortgage is better suited for people willing to take a risk on what their rate will be, while those who are risk averse are advised to choose a fixed rate.
Mortgage rates are influenced by Canadian bond markets, as well as the Bank of Canada’s overnight rate, the latter now sitting at 3.25%, down from 5% a year ago.
Lower interest rates have awakened Canada’s housing and mortgage markets, says Sal Guatieri, senior economist and director of Economics at BMO Economics, in a new report.
“Annual growth in residential mortgages has reached 4% for the first time since mid-2023,” writes Guatieri. “Sensing the central bank may reduce rates further, more borrowers are opting for a floating rate loan. But is that the right choice?”
“If the rate outlook unfolds as we expect, it could well be.”
Variable rates are currently slightly above five-year fixed rates, but Guatieri says that could soon change, with the assumption the Bank of Canada reduces its rate to 2.5% by July.
In that event, “a floating rate could pay off handsomely,” says Guatieri. “We estimate a borrower putting 10% down on a half-million-dollar home financed over 25 years would save an average of 40 basis points per year compared with locking in for five years. That equates to just over $100 per month or more than $6,000 in five years.”
Pending US tariffs and an ensuing trade war, the bank could further cut its rate.
“If a trade war torpedoes the economy, the bank could reduce rates aggressively, possibly by an additional 100 basis points to 1.5%,” says Guatieri. “And, assuming that rates stay low for a full year, variable-rate borrowers would save an additional 29 basis points on average in five years, or an extra $74 per month. They would not only benefit from potentially much lower rates, but also have the option to lock in should rates rise unexpectedly.”
BMO Economics’ rate forecast is in line with the market’s expectations of a 50-basis points reduction this year.
“Still, there’s no guarantee the bank will lower rates further. Recent comments suggest a more patient approach after chopping rates by 200 basis point (in the last year) to the upper end of a neutral range,” says Guatieri. “The bank was also vague on its ‘Plan B’ for tariffs, given the uncertain inflation response, though we suspect a rising jobless rate would throw caution to the wind.”
“Should the bank stand pat on rates, locking in could pay off moderately.”
The economy could strengthen materially if a trade war is averted, which would likely cause inflation to flare up again leading the bank to reverse its rate-cutting trend.
“In this case, a fixed rate would clearly be the better choice,” says Guatieri. “Even if policy rates fell moderately further, locking in at rates that already reflect future policy easing might be worth the cost of insuring against the risk of higher interest rates.”
A third option would be taking a fixed rate with a term of less than five years, says Guatieri.
“This provides an opportunity to refinance at a possibly much lower rate in a few years,” he says. “For example, the three-year mortgage rate is currently modestly below the five-year rate, and could be renewed at a lower variable rate in three years based on our outlook for policy rates, saving an average of 20 basis points over five years relative to the current five-year rate."
“While that’s still 20 basis points higher than opting for a variable rate today, the extra cost may be worth paying to hedge against potential rate increases.”
Guatieri’s bottom line is interest rates are more likely to fall than rise.
“A variable rate mortgage could be an attractive option when refinancing or buying a home,” he says. “Still, this is an intensely uncertain period and borrowers have different needs based on their financial position and risk tolerance.”
Guatieri says it’s a must to speak to a mortgage advisor to weigh all the options and determine the level of risk with which you are comfortable.
