Fixed vs. variable: Could a change in borrower preferences be ahead?

Variable rates look set to fall in the coming months

Variable rates may have inched downwards after the Bank of Canada’s decision to lower its benchmark rate on June 5 – but even with further cuts expected for the rest of the year, there seems little chance of an imminent borrower surge towards those mortgage types.

As the central bank slashed its trendsetting rate to a rock-bottom 0.25% at the onset of the COVID-19 pandemic, borrowers rushed to take advantage of ultra-cheap variable-rate mortgages, a trend that ground to a halt when the Bank rate (and as a result, bank prime rates) began to climb in early 2022.

Borrowers have tended to prefer the security of fixed-term options in that rising-rate environment – especially fixed mortgages between one and three years, as reported by Canada and Mortgage Housing Corporation (CMHC) – to keep payments steady while also keeping an eye on the prospect of lower variable rates down the line.

The Bank’s decision to bring rates down for the first time in over four years will have changed little in that regard, according to BlueShore Financial advisor Justin Prasad (pictured top).

With the prime rate currently sitting around the 6.95% mark, borrowers would need a significant discount for a variable-rate mortgage to be a better option than a fixed-rate one, he told Canadian Mortgage Professional.

“For a five-year fixed, you’re really looking at the low five [percents] now. And so really, if you’re taking a variable that’s prime minus one – which I’m not seeing at all – that gets you to what a five-year fixed is now. So now you’re on equal plains.

“But then you’re really banking that over the next couple of years, that rate’s going to come down significantly, which it might – but it’s going to be a gradual process.”

Even variable-rate options offering prime minus one half or quarter, Prasad said, will be less appealing to many borrowers in the current market than a short-term or five-year fixed-rate mortgage.

“It’s just not attractive at this point, because I don’t see rates coming down significantly,” he said. “If we were in a situation where… I [could] see the Bank cutting rates [substantially] this year, then yeah, the variable is definitely attractive. But I just can’t see that happening, especially with the situation in the States and what the US Fed is doing there.”

How are banks likely to react to borrowers’ changing preferences?

Borrowers may have gravitated more towards shorter-term fixed rates than five-year options in recent times in the hope that they’ll be able to avail of significantly lower rates after a few Bank cuts. Still, major banks have become attuned to that prospect and could become eager to make longer-term fixed options more attractive, according to Prasad.

That means less of a spread difference may emerge between one-to-three-year mortgages and five-year options, he said, as banks seek to lock in borrowers at longer rates.

“If they’re in a situation where they know they can lock in somebody for five years at, let’s even call it 4.99% or 4.85%, why would they not do that in a declining-rate environment?” he said.

“I think what you’ll probably see is great five-year deals – but a two-year might be 5.5% or 5.4%, where they’re really pushing people to make a decision of going in the five-year. But right now, the sentiment is for sure people wanting to go into a two-year, three-year fixed-rate mortgage.”

How can five-year-fixed borrowers avail of lower rates before that term ends?

A potential hack for borrowers locking into a five-year fixed mortgage but who also want to avail of lower rates in a couple of years, Prasad said, is a blend and extend – meaning that if they take a five-year fixed at 5% and rates have come down significantly in two years’ time, they can blend both of those rates together and extend the mortgage out.

“That’s what I always tell clients: you’re not really locked into a five-year. You have the options to do a blend and extend,” he said. “And we did a ton of those back in 2021 when rates were super-low, and people were able to blend with that lower rate and extend it out.”

Of course, that won’t necessarily be an option for every mortgage type. “So my advice there is you need to speak to your lender and really know what the terms and conditions of your mortgage are,” he added, “and what that allows for you.”

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