The latest announcement from the Bank of Canada stated that the country’s overnight interest rate will remain locked at 1 percent for a longer period of time. Some of the language used in the announcement even hinted that a rate cut is now more likely than a rate hike.
What does this mean for people looking for a mortgage, specifically – is a fixed or variable rate mortgage plan the better option? Unfortunately there is no concrete way to say which option is the ‘right option’ as each individual homebuyer must address his or her own personal needs rather than following remarks from economists.
Decisions made by the BoC inevitably affect variable rate mortgages as banks and brokers adjust their prime lending rates based on the actions of the bank. With the announcement that a rate hike appears to be off the table, this makes variable rates appear attractive to the average Canadian eager to save as much money as possible on their mortgage.
However, I personally believe that fixed mortgage rates are a more secure alternative, particularly for young Canadians buying their first home. We as Canadians are generally not impulse buyers, and are very cautious about how we spend our money.
First, let’s look at the facts.
(1) BoC Switches Governors, Rides Out Summer
Prior to leaving Canada, former BoC Governor Mark Carney stressed that interest rates eventually must rise with inflation. His position was reiterated by his successor Stephen Poloz as recently as September, when he offered a metaphor that low interest rates are filling a shallow river that Canada must row its economic boat across.
But that river was getting dangerously close to overflowing, and unwanted consequences could float to the surface.
“We need to make sure we're getting to shore and not just hitting a rock.”
(2) Post-Summer Reactions
Fast forward six weeks, and everything changed. The BoC slashed its economic growth projections for 2014 and 2015, while suggesting Canada’s hands are tied by weaker than expected economic performance from other nations, including the US.
In one month, we go from language that rates must rise to avoid “hitting a rock” to the economy is unable to afford a rate hike. In September it looked as if variable mortgage rates would rise with a possible overnight rate hike – in October, rates are expected to remain in place or potentially drop.
This kind of uncertainty is something I believe Canadians, and young Canadians in particular cannot afford to take a chance on. Yes variable plans may save more money than fixed mortgages now, but who knows what could happen by Christmas or shortly into 2014?
Anyone interested in buying a home must address their own unique needs, and map out an affordable budget to pay off the mortgage, as well as all other expenses associated with the home. If that budget leaves little wiggle room for a sudden rate hike, a variable plan can unexpectedly cost thousands of extra dollars with little to no warning if the BoC finally decides to take action.
But Canadians who select fixed rate mortgages can avoid these types of uncertain and anxiety-fuelling questions. Interest rates on fixed term loans remain the same over the length of the agreement, which means we always know what we will pay each month for the entire duration of the mortgage.
The average fixed rate mortgage is slightly over 3 percent across Canada, while variable rates are slightly below 2.5 percent. Right now, the variable plan seems more appealing but as was the case in the summer, anything could change month to month. Those changes could carry expensive consequences for people who take their chances on loans that are not secured by locked in rates.
Security and stability are two themes championed by experts as the strengths of the Canadian economy compared to other nations, and are just as important for homebuyers. A home is one of the most important financial investments we can make as Canadians – we should feel safe, secure, and at peace with our asset.
If you are a young Canadian or at all worried about changes to the cost of financing a home, choose the Canadian approach – secure, stable fixed rate mortgage plans. But we also have an argument in favour of variable rate mortgage options for people who want another perspective.