Borrowers' preference for variable over fixed rates has changed course in recent months
One of the most prominent discussion points between brokers, agents and their clients, the fixed-versus-variable debate, took a significant swing in 2022 as a big trend of previous years began to reverse.
Variable-rate mortgages had seen a major uptick in popularity after the outbreak of the COVID-19 pandemic in Canada because those options are tied to the Bank of Canada’s trendsetting interest rate, which the central bank slashed to a rock-bottom low in 2020 as the economic impact of public health restrictions and widespread business closures became clear.
That saw the share of mortgages on variable rates in Canada peak at 56.9% at the beginning of 2022 – just before the Bank set off on a series of rate hikes that has spiked its policy rate by 4.25 percentage points and brought a swift end to the outsized popularity of variable rates.
By the second quarter of last year, the share of mortgage holders on variable rates had dwindled to 44.2%, according to Canada Mortgage and Housing Corporation (CMHC), with that percentage likely to fall even further as the impact of the Bank of Canada’s rate increases becomes clear.
Meanwhile, fixed rates have slipped thanks to a recent fall in the Government of Canada’s 5-year bond yield, with those rates usually rising or falling in tandem with that yield.
What borrowers are keeping in mind about the fixed-vs-variable question in 2023
While the central bank said it was ready to hit pause on its rate hikes following the 25-basis-point jump in January, there appears no imminent prospect of cuts to its trendsetting rate – and no further upward movement is dependent on inflation and other economic indicators trending in the right direction.
With that in mind, new variable rates are unlikely to be appealing as fixed to all but the most optimistic economic observers, according to RateHub.ca’s co-CEO and co-founder James Laird (pictured top).
“I think it requires a high risk tolerance and a lot of conviction in your outlook to take a new variable rate right now because usually variables start lower than fixed rates,” he told Canadian Mortgage Professional. “So if nothing happens, you’re already saving money.
“In this case, your rate starts higher so you need to have a reasonable amount of conviction in rate cuts reasonably soon for you to think that that’s a better strategy. So I think to take a variable at the moment, you would have to feel that inflation is going to be well under control, that we’re going to hit those targets of 3% this year and 2% next year.”
Laird was referring to the Bank of Canada’s projection that CPI (consumer price index) inflation should fall to 3% by mid-2023 and its target rate of 2% at some point next year.
The Bank of Canada has probably reached the end of its rate-hiking cycle for now – but it still needs to keep Canadians on their toes about the possibility that that could change, according to CIBC’s Benjamin Tal.https://t.co/fWTuj5MB5K
— Canadian Mortgage Professional Magazine (@CMPmagazine) January 26, 2023
Variable borrowers must also be somewhat confident that a slowing economy will result in “reasonably significant” rate cuts in 2024, he added, which would push variable rates lower than their fixed counterparts.
“It takes a lot of conviction in that, especially since you have to bite your lip because you know for sure you’re paying more in the beginning,” he said.
However, some variable borrowers may choose to ride out their present rate despite it currently being high, he said, taking a longer-term outlook in the expectation that over the course of the entire amortization it will turn out a better option than switching to a fixed rate.
What would it take for variable rates to fall in 2023?
Despite the Bank of Canada appearing to have reached the end of its rate-hiking path for now, the possibility of the central bank actually cutting its benchmark rate this year appears next-to-none.
That’s because the Bank is still clearly concerned about inflation, which has fallen in recent months but at 6.3% still remains well above its target rate.
While the economy slowed in November, seeing growth of just 0.1% according to Statistics Canada, the labour market has also remained resilient, with 104,000 jobs added in December.
That’s likely to strengthen the Bank of Canada’s conviction that rates need to remain high for the foreseeable future to weigh against the possibility of the economy gathering pace again.
What are you advising clients on the fixed-vs-variable question? Let us know in the comments section below.
