Tan•gazine January 2021 Vol 6 Issue 05

Should You Get a Fixed-rate or Variable Mortgage? In
These Strange Times, Fixed Has a Rare Edge
DAVID ASTON
TORONTO STAR
NOVEMBER 20, 2020
One of the classic personal-finance
questions that mortgage borrowers
face when they renew is whether to go
with a variable rate or lock in a fixed rate
for five years. It turns out that financial
conditions now tend to favour the choice
of a five-year fixed rate mortgage to an
unusual degree.
For one thing, it’s likely that longerterm
interest rates, including five-year
mortgage rates, have either bottomed
or are close to it. Most economists
forecast that longer-term rates will
increase from roughly where they
are now in step with the economic
recovery, although they expect a gentle
and gradual rise.
“We’re starting at the low point of a
business cycle meaning interest rates
are at a floor,” says Beata Caranci, chief
economist at TD Bank Group.
Also, while it’s normal to pay a higher
rate for five-year fixed compared to
variable, right now there is little rate
difference between them. “You’re
paying an historically small premium
for rate certainty,” says Robert McLister,
founder of RateSpy.com. “There was a
time not long ago when you could get
a one per cent edge by going variable
instead of five-year fixed and you’re not
getting that right now.”
Of course, the right choice of
mortgage type depends critically on
personal preferences and individual
circumstances. Also, rate forecasts
always come with a high degree of
uncertainty. But overall, “you have to
say to yourself that ‘my chances of
being right with the five-year fixed is
probably greater than my risk of being
wrong,’” says McLister, who is also
mortgage editor at Rates.ca.
Mortgage advice is different now
Now we consider why this viewpoint is
different from the standard mortgage
advice that you may have heard in the
past. Historical studies have shown
that most of the time you would have
saved money going with variable rates.
But key factors that drive that result
don’t apply at the moment. Since you
don’t currently pay a premium for
five-year fixed, as is common during
more prosperous times, variable rates
don’t have the built-in head-start to
saving money that they have frequently
enjoyed.
In addition, as McLister points out,
interest rates were until recently on a
general downward trend over a period
of almost 40 years. In many instances,
falling variable rates would have saved
you money during the term of your
mortgage when fixed mortgages were
left anchored higher. But both variable
and five-year-fixed mortgage rates are
now at ultralow levels and there isn’t
much difference between them.
Competitive five-year fixed rates and
variable rates are both around 1.7 to
1.8 per cent for uninsured mortgages in
Ontario as of Friday, says McLister. Oneyear
fixed mortgage rates are slightly
higher, at around 1.9 per cent, he says.
(Those rates are for mortgages with a
minimum 20 per cent down payment,
sourced directly from lenders which
charge relatively moderate penalties
for breaking a mortgage term early. You
might find lower rates on mortgages
with harsher penalties, more restrictive
terms or requiring default insurance.)
So variable rates don’t have a built-in
rate advantage right now. If anything,
variable rates might rise somewhat
towards the end of a five-year mortgage
term when the economy is more fully
recovered, although there is little threat
of much of an increase over at least the
next couple of years.
Low rates in the forecast
You’ve probably heard how the Bank
of Canada is committed to keeping
interest rates low for the foreseeable
future, but understand how that works
in practice.
While short-term and variable rates
aren’t expected to change much if at all
in the next two years, most economists
say longer-term yields are likely to
gradually and moderately rise in step
with the recovery. That should result
in the yield curve returning to its more
normal upward slope, whereby longerterm
rates are higher than short-term
and variable rates.
The Bank of Canada has a stronger
impact on variable and short-term rates
than long-term rates. It establishes
the benchmark for variable and shortterm
rates through its setting of the
“overnight” interest rate (also called the
“policy” rate), which is the target rate
for major financial institutions lending
and borrowing between themselves for
one day (that is, overnight). Variablerate
mortgages are set in relationship
to the prime lending rate, which in turn
has a close relationship to the overnight
rate.
Longer-term yields are determined to
a large extent in the bond market and
reflect the market’s assessment of
factors including long-term growth and
inflation prospects, and especially the
interaction with U.S. and international
interest rates, says Caranci. Thus
longer-term rates tend to rise during
periods of global economic recovery
with a degree of independence from
Bank of Canada actions.
Of course, the bank’s policy rate
influences long-term rates. The bank
also has a direct impact these days
through its current massive bondbuying
program known as Quantitative
Easing. As a result, the Bank of Canada
can be expected to help moderate and
smooth out the rise in long-term rates,
but it doesn’t fully control them.
“The long term end of the yield curve
is not pinned to the policy rate per se,”
says Caranci. “It rises ahead of your
policy rates.”
Five-year fixed mortgage rates are
largely driven by the benchmark of fiveyear
Government of Canada bond yields.
Financial institutions apply a premium
to those bond rates to ensure they
cover their costs and credit risks. As of
Thursday, the Government of Canada
five-year benchmark bond yield was
0.44 per cent, as reported by the Bank
of Canada. In their October forecast,
TD Bank Group economists projected
that those five-year bond yields will
gradually rise to 1.25 per cent by the
end of 2022.
Those forecast rates two years out
are still low by past norms. “We’re so
abnormal in terms of the low level of
yields right now,” say Caranci. “Even as
we ‘normalize,’ it’s not normal.”
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