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Fixed-mortgage rates have been at ultra-low levels for a long time, so it’s not surprising that the vast majority of borrowers have been opting for the comfort and familiarity of the ‘banker’s favourite’ five-year fixed term (here is a post I wrote that explains why I call it that). But after the recent increases to five-year fixed rates, I think there is an increasingly compelling case to be made for the variable rate instead.
Here are five reasons why I think the five-year variable rate is worth a fresh look:
- For much of the past year, the spread between five-year fixed and variable rates was less than 0.25%, which meant that it would take only one increase by the Bank of Canada (BoC) to make five-year variable-rate mortgages more expensive than their fixed-rate alternatives. After the latest round of fixed-rate increases, this spread is now greater than 0.50%, which gives variable-rate borrowers a wider ‘margin of safety’ between variable and fixed rates.
- If you’ve recently agreed to purchase a home or have a renewal coming up, you need a mortgage at a specific future date. If the vagaries of bond-market investors happen to push up five-year GoC bond yields at the same time that you need a mortgage, opting for a five-year fixed rate locks in that short-term yield spike for the next five years. Conversely, variable rates don’t move until the BoC raises its overnight rate and this happens much less frequently, and on a more measured and considered basis.
- When borrowers dismiss the variable-rate option, the most common justification I hear is that they’re worried they won’t be able to afford future rate increases. Most of these same borrowers are surprised to learn that they can only qualify for a variable-rate mortgage if they prove that they can afford a doubling of rates over the next five years. That’s because lenders now qualify variable-rate applicants using the BoC’s Mortgage Qualifying Rate (MQR) which currently sits at 5.14% (here is a post I wrote that explains the MQR in detail). If you can pass the MQR’s stringent test, then you should feel confident that you can afford substantial, and even unlikely, future rate increases. Variable-rate mortgages also come with the option to convert to an equivalent fixed rate term at any time with no penalty. While the conversion rates offered by different lenders can vary widely, this free lock-in option gives you the ability to eliminate further variable-rate risk.