When should you convert your variable rate into a fixed rate?

Interest rates in Canada have gone up a whopping eight times over the past year. 

Homeowners with variable rates have been braving the storm, while those with fixed rates have been sheltered by their terms. These fluctuations have led many Canadians to wonder: “When, exactly, is the right time to lock in my interest rate?”

Understanding the Current Mortgage Landscape in Canada

Historical Context and Recent Trends

In recent times, Canada has witnessed a historic rise in interest rates, a stark contrast to the pandemic-era lows. This increase has significantly impacted homeowners, particularly those with variable-rate mortgages. In 2023, the preference for variable rates has notably declined, with only 5% of mortgage inquiries for variable rates compared to 26% in the previous year. This trend underscores a growing inclination towards the stability offered by fixed rates amidst economic uncertainties.

Impact of Rising Rates on Mortgage Payments

The surge in interest rates has tangible implications on mortgage payments. For example, a typical mortgage balance of $500,000, which seemed manageable in early 2022, now incurs substantially higher interest payments. This escalation poses budgeting challenges for many homeowners, emphasizing the need for predictable financial planning.

Options for Mortgage Holders

Homeowners currently on variable-rate mortgages face critical decisions. Converting to a fixed-rate mortgage can lock in a stable rate, providing peace of mind against future rate hikes. Alternatively, refinancing the mortgage might offer more favourable terms, though it's crucial to weigh the potential costs and benefits. Staying with a variable rate also remains an option, albeit with its inherent risks and potential rewards.

Decision-Making Factors

The decision to switch hinges on several factors. Future interest rate projections, though speculative, play a crucial role. Equally important are personal financial circumstances and long-term goals. Each homeowner's situation is unique, and their choice should align with their risk tolerance and future plans.

What rates are people taking in this environment?

In 2023 Statistics Canada reported that in the month of June, the chartered banks advanced funds on $8.2 billion in insured residential mortgages. Of those, only $370 million were under a variable rate mortgage. This accounted for 4.5% of total insured mortgage volume. In the same time period, the chartered banks advanced funds on $39.5 billion of uninsured residential mortgages. Of those, only $2.3 billion were under a variable rate mortgage. This accounted for 5.9% of total uninsured mortgage volume. To provide a comparison to June 2021, for the exact same comparison, variable mortgages accounted for 28.6% of insured mortgages and 49.5% of uninsured mortgages. It's clear that in this rising rate environment, Canadians have migrated primarily to fixed rate mortgages, largely leaving variable mortgages behind.

Fixed-rate vs. variable-rate

When it comes to locking in a mortgage, you’ll often have two choices to pick from, right from the start: a fixed-rate or a variable-rate. 

As the name suggests, a fixed mortgage comes with a standard rate throughout a mortgage term. For example, if you secure a 3.1% interest rate for five years, you can expect your payments to stay the same until that time is up. On the flip side, a variable rate changes in response to the Bank of Canada’s changes to the country’s prime rate.

Because of the unpredictability of variable rates, they are generally lower than fixed mortgage rates. Fixed mortgages come with a lower risk than variable because your payments are the same, regardless of the prime rate. Switching from variable to fixed is often easier, however switching from a fixed to a variable will typically result in a larger penalty fee.

Which is better?

The answer to this question really depends on your personal financial situation, the rate environment and risk tolerance. If you're someone who values stability and predictability, a fixed rate mortgage may be the better choice for you. You'll know exactly how much you'll need to pay each month, which can make budgeting and planning your finances easier.

On the other hand, if you're comfortable with a bit of uncertainty and are willing to take on a bit of risk, a variable rate mortgage could be best. With this type of rate, you could end up paying less interest over the life of the loan if interest rates fall. However, you'll need to be prepared for the possibility that your monthly payments could go up if interest rates rise.

When deciding on what rate type works best for you, keep in mind that if you are planning to sell your property in the near future, within the term of the mortgage, it is often better to stick to a variable rate. This is because variable rates have lower penalties upon breaking. Before selling your home, you will have to break your mortgage before the term is over.

When should you convert your variable rate into a fixed rate?

Interest rates are rising

If interest rates are on the rise, it may be a good time to switch to a fixed rate mortgage. With a fixed rate mortgage, your interest rate will remain the same for the entire loan term, even if interest rates continue to rise. This can provide peace of mind, especially if you're planning on keeping the loan for a long time. By switching to a fixed rate, you'll know exactly how much you'll need to pay each month, making it easier to budget and plan your finances.

Often, in these situations, fixed rates are higher than variable mortgage rates. In that case, it is important to do some scenario analysis to understand how much your mortgage payments will rise if the switch is made. Will this increase be worth the risk of mortgage rates rising further and the peace of mind that a fixed mortgage rate will give. Take a look at our mortgage refinance calculator to get a better understanding of breakage fees and how much your new mortgage payment is going to cost.

You need predictability and stability 

If you value predictability and stability, switching to a fixed rate loan may be the right choice for you. With a fixed rate loan, your monthly payments will be consistent, making it easier to budget and plan your finances. 

And if you're concerned about the economy and the potential for interest rates to fluctuate in the near future, a fixed-rate mortgage can provide you with a sense of stability and certainty. Similarly,  if you experience fluctuations in your income or if you work in an industry that is prone to economic uncertainty, with a fixed-rate mortgage, you'll have the security of knowing that your payments will stay the same.

This can all be particularly important if you're buying a home in a volatile market, if you’re close to retirement, or if you're planning on making a large purchase in the near future.

Your budget is tight

If your budget is tight and you're finding it difficult to keep up with your monthly payments, switching to a fixed rate loan may help. A fixed-rate mortgage can make it easier to budget and plan your finances. Since your payments are the same each month, you can better predict your expenses and plan accordingly. This can provide peace of mind and help you avoid falling behind on your loan payments.

How are mortgage breakage fees calculated?

Variable rate mortgage breakage fees

With variable rate mortgages, if you were to break the mortgage within the term (3 year or 5 years typically), you will have to pay a penalty of three months worth of interest. This amount stays the same whether you have 1 year left in your mortgage or 4 years. This is what makes variable rate mortgages more flexible than fixed rate mortgages. If you may sell your property to upgrade to a bigger home within the mortgage term, this penalty fee may be more reasonable.

The lender anticipates a certain amount of interest over the life of the mortgage. By paying it off early, they lose out on the expected revenue. This breakage fee compensates the lender for this loss of potential interest.

Fixed rate mortgage breakage fees

With a fixed-rate mortgage, the penalty calculation gets a little more complicated. The method used is the higher of 3 months of interest or the interest-rate differential (IRD). The interest rate differential is calculated by finding the difference between the interest borrower would have paid if they had kept the mortgage for its full term and the interest they would pay at the current market rate. This amount is often much higher than the 3 months of interest that a variable rate mortgage would incur upon breakage.

Surprise fees that may occur when breaking a mortgage

Administration Fees‍

When breaking or refinancing a mortgage in Canada, lenders often impose an administration fee. This fee covers the costs of processing the early repayment or administrative changes to the loan. Typically, it accounts for paperwork, administrative labor, and other related operations. While it varies across institutions, borrowers can expect to pay a flat fee that usually ranges between $200 and $500.

Appraisal Fees

Should you choose to refinance your mortgage or take out a home equity line of credit, the lender might require a new assessment of your property's current value. This entails hiring a professional appraiser to evaluate your home. The cost of this service falls upon the borrower and can fluctuate based on the home's location and size, but fees generally range from $300 to $500.

Reinvestment Fees

A lesser-known fee in the mortgage landscape is the reinvestment fee. Some lenders charge this to compensate for the loss they might face when reinvesting funds repaid earlier than anticipated, often at lower current interest rates. It's crucial to differentiate this from the interest rate differential (IRD) penalty. The latter covers the interest difference between your locked-in rate and the rate at which the lender might lend the money in the current market.

Mortgage Discharge Fees‍

Completing the repayment of a mortgage requires the removal of the lender's "charge" or "lien" against the property, a process termed as a "discharge." The associated costs, called discharge fees, can differ based on provinces in Canada. For instance, provinces like Ontario have standardized these fees, while others might not. It's also worth noting the difference between a "discharge" and a "transfer." If a borrower is merely switching lenders and retaining a mortgage, they might be transferring the charge, potentially incurring different fees. Depending on the province and specific lender, discharge fees can lie anywhere between $50 and $300.

The bottom line…

If you're considering switching from a variable rate to a fixed rate loan, it's important to consider your personal financial situation and risk tolerance. A fixed rate loan provides stability and predictability, while a variable rate loan offers the potential for lower interest payments if interest rates fall. Whichever option you choose, make sure to shop around to find the best deal. And if you’re ready to lock in, fill out Pine’s quick-and-easy application, so we can get you in touch with a mortgage agent to help you with the switch.