Variable Interest Rates

June 30, 2017

 

 Are rates staying? Are they going up? Do I lock in? What do I do?

 

Interest rates, especially when it comes to mortgages is like trying to predict the future- you can never be 100% certain. Even the people working for the Bank of Canada don’t know because factors such as unemployment, bond yields, GDP, and currency help them make their decision. These items cannot be predicted to an exact science so neither can interests rates.

 

However, what we can do is conduct an approximation. As of right now, when the Bank of Canada wants to increase interest rates, they increase their overnight rate. This is the interest rate they charge banks and lenders for borrowing money. Then the banks will pass this increase or decreased cost on to the consumers. If the Bank of Canada increase their interest rates, the banks will do the same in order to keep the same profit margins- they don’t have to but they do.

 

So, with the overnight rate currently at 0.5, all bank’s have a prime lending rate (other than TD) of 2.7%. Most banks have a 5-year fixed rate around 2.6%, 2.5%. Variable interest rates are hovering around prime (2.7%) minus 0.5, 0.6 (2.1%, 2.2%).

 

Interest rates as of right now will go up before they go down in Canada. However, there hasn’t been a period of more than 6 months in the history of the Bank of Canada where they have increased the overnight rate by more than 0.25%. They can only change their interest rate 4 times in a year (quarterly meetings). So, theoretically the overnight interest rate can only change by a full percent in a single year. But what does that mean for prime lending rates at the bank level?

 

Last time the Bank of Canada dropped the overnight rate by 0.25%, banks lowered their prime lending rate by 0.15%. So, if we make these assumptions, the prime rate shouldn’t move by more than 0.15%. With only three meetings left, that would be 0.45% for the rest of the year- maximum.

 

Your 2.1%, 2.2% variable interest loan might go up to 2.55%, 2.65%, still lower than some 5-year fixed interest rates available right now. Plus, the penalty to break a variable mortgage and pay it out early is significantly (thousands and thousands of dollars) less than paying to break a fixed interest rate mortgage. This is one of the reasons why I would be a strong supporter of the variable interest rate, especially with everyone now having to qualify at the 5-year benchmark rate of 4.64%.

 

A lot can happen in 5 years, however, locking yourself into a fixed interest rate that is almost half a full percent point more than available rates seems unattractive, especially when they have a higher penalty. Just because rates are headed up, doesn’t mean they are staying and doesn’t mean they can come back down.

 

If you have any questions about variable rates or want to know more, please, do not hesitate to contact me!

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