Preparing for a Property Purchase: Fixed or Variable Rate Mortgage?

As you prepare to purchase a property, the first step is obtaining a mortgage pre-approval. You've been keeping up with the news and are aware that the long-awaited drop in high interest rates has finally occurred. But does this mean you should opt for a variable rate mortgage instead of a fixed rate? Well, the answer isn't so straightforward.

Firstly, consider that the fixed rates offered by banks are currently lower than the variable rates for 5-year closed terms. This difference can be more than 1% depending on the lender. This means that if you choose a 5-year closed variable rate mortgage today, you would need to hope that the Bank of Canada reduces its key interest rate by more than 1% in upcoming announcements to truly benefit from the variable rate.

For illustration, let’s take a $250,000 loan with a 20% down payment. As of now, based on your profile, you could secure a fixed rate resulting in an uninsured monthly mortgage payment of around $1,200. In comparison, based on current variable rates, your payments might be closer to $1,350, a difference of about $150 per month as long as the key interest rate doesn't change. Therefore, in the short term, choosing a variable rate might not be your best option if the Bank of Canada doesn’t lower its key rate.

To really start benefiting from a variable rate, the key rate would need to decrease by more than 1% quickly. At a quarter-point reduction each time, this could take a while unless the Bank of Canada continues or even accelerates rate cuts. Notably, the next rate announcement from the Bank of Canada is scheduled for tomorrow, July 24, 2024, which could bring a new rate cut. There are also further announcements scheduled for September 4, October 23, and December 11. Anything is possible!

That said, the likelihood of the key rate continuing to drop is very plausible. Indeed, it is highly probable that inflation will hit the central banks' target by next year, justifying further rate cuts. Additionally, if the Canadian economy enters a recession, it is also very likely that the key rate will decrease even faster, favoring the variable rate option.

For those uncertain about the future of interest rates, considering a 3-year fixed rate mortgage might be a good trade-off. This option provides the stability of fixed payments while not committing you to a longer-term fixed rate that might be higher than future rates.

Conclusion

It all depends on your confidence in the Canadian economy. If you believe that interest rates will continue to fall, a variable rate could help you save on your loan over the next five years. For those seeking a balance between stability and flexibility, a 3-year fixed rate mortgage can offer peace of mind amidst uncertainties. To make an informed decision, it is best to consult a mortgage broker. Your real estate broker works with many real estate professionals and can refer you to trusted experts if needed. Don't hesitate to ask for their advice.