Variable rate mortgages – what's in store?

As 2021 rumbles to a close and mortgage professionals start to look ahead to the next calendar year, one of the big questions ahead will be whether variable-rate mortgages continue the sky-high popularity they’ve witnessed throughout the pandemic.

With clients continuing to capitalize on variable rates that plummeted to record lows as the impact of the pandemic took hold, many brokers have reported surging interest in those products throughout this year and last – a trend that could be set to continue despite the inevitability of eventual interest rate increases down the line.

Shawn Stillman (pictured), principal broker and co-founder at the Toronto-based Mortgage Outlet brokerage, told Canadian Mortgage Professional that the current difference between variable and fixed rates meant that any changes to the prime rate would have to be dramatic for variable to reach parity with fixed.

“The spread now is over a percent. Assuming that interest rates kind of go up in a straight line over the next five years, when there’s a spread of one percent that means interest rates have to go up eight times over the next five years for the rates to equal out,” he said.

Stillman said that while rate increases were undoubtedly on the way, they were unlikely to be dramatic enough over the course of a five-year mortgage to justify missing out on current low variable rates.

Read next: Does the BoC announcement spell trouble for variable rates?

He also noted less severe penalties for breaking variable-rate mortgages as a prominent consideration for clients who choose those products over fixed-rate options, particularly when there’s no guarantee that life circumstances won’t change over the course of that five-year period.

While penalties for breaking a variable mortgage amount to a charge of three months’ interest, fixed-rate mortgages usually have a costlier penalty, the interest rate differential, if that amount is higher than that three-month-interest payment.

“People have been so burnt by what fixed penalties are at the major banks that my first question to clients is: ‘Is there any chance of you breaking this mortgage in the next five years?’” he said.

“If there’s any hesitation or doubt whatsoever, you’re just trading risk: interest rate risk versus penalty risk. You might pay $1,000 or $2,000 more of interest, but you might [also] save $20,000 in the penalty if you break it.”

While many clients who opt for fixed rates do so because of the security that option can offer, Stillman said that it’s something of a risk to choose a particular product in the belief that circumstances are unlikely to change over the course of the five-year contract.

He emphasized that while the perception of a five-year rate has been reinforced as the correct option by many banks and lenders, borrowers needed to assess whether they felt confident that they had no potentially impactful changes coming down the line.

Read next: The case for variable rates

“Life changes very quickly. Good things happen, bad things happen, people move, people switch jobs – so to say, ‘I want something for five years’ is a huge leap of faith,” he said.

“A line I use is: ‘Think about where you were five years ago. Think about where you are now. Would you be making these decisions five years ago if you knew where you were going to be now?’ The answer, of course, is ‘no’.”

For clients, Stillman’s advice is simple. “I say make the best decision today that you could make and if you change your mind tomorrow, we can adapt to that,” he said.

“But don’t be paralyzed in making a decision. Don’t wait and see because the market is moving fast; and then go from there.”

The Canada Mortgage and Housing Corporation (CMHC) caused something of a stir recently by labelling Canada’s housing market as overheated and highly vulnerable, issuing its highest risk rating for the country’s housing sector.

Despite that warning, Stillman said that he hasn’t seen many clients deterred from continuing with their homebuying goals – particularly given the fact that the statement was consistent with the agency’s rhetoric over the past several years.

“It doesn’t come up in conversation [with clients] whatsoever,” he said. “That’s what they’ve been saying for the last X number of years, that the market has been overheating. Anyone who’s listened to them has got further and further behind.”