Time to Re-consider the Variable-Rate Mortgage?

David Larock in Mortgages and Finance, Toronto Real Estate News

Egg thinkerVariable-rate mortgage discounts aren’t what they used to be and for that
reason, I have tended to favour fixed-rate options for some time now. Here,
based on steadily accumulating economic data, is the case for the contrary

A good five-year variable-rate mortgage can now be found in the prime minus
0.40% range (which works out to 2.60% using today’s prime rate), compared to
prime minus 0.75% or better in years past (which works out to 2.25% or lower
using today’s prime rate).

At the same time that variable rates have been rising due to shrinking
discounts, five-year fixed-mortgage rates have dropped to record low levels of
3.00% or less. Not surprisingly, with such a small gap between fixed and
variable rates, just about anyone who has been in the market for a mortgage over
the past year has chosen fixed.

But now that the best available one-year fixed rate has been increased, the
five-year variable-rate mortgage is once again the cheapest way to borrow money
in today’s market. And while variable rates can theoretically rise quickly, that
seems increasingly unlikely in the current economic environment.

Those were the initial factors that got me scratching my contrarian itch. And
the more I have thought it through, the more convinced I have become that the
variable-rate option should no longer be dismissed out-of-hand.

First, consider these five reasons why I don’t think variable rates will
materially increase any time soon:

  • The bond market has an outstanding track record of correctly forecasting the
    direction of inflation and economic growth rates. At their current levels, bond
    yields are saying that inflation and growth will remain low far into the
  • Many central banks around the world have their printing presses going around
    the clock and they have taken this extraordinary measure because they are
    worried about deflation, not inflation. To use the U.S. as an example, so far,
    despite the U.S. Fed’s concerted efforts, the new money that has flooded into
    the economy is simply not circulating and overall U.S. inflation has remained
    benign. This is because risk-averse lenders are reluctant to lend and
    over-leveraged borrowers don’t want to borrow. Neither trend appears likely to
    change any time soon.
  • While commodity prices have been on a fairly steady upward climb in recent
    years the cost of discretionary items has been consistently falling. It stands
    to reason that if you have to spend more of your income on the basic items that
    you need for survival (like food and fuel), you will have less money available
    to spend on discretionary items that come from highly sensitive sectors of the
    economy that are important for job creation and economic growth.
  • Despite unprecedented levels of stimulus from the U.S. federal government
    that have come at the cost of record debt and deficit levels, the U.S.economy is
    in the midst of its weakest economic recovery ever. Normally, an economy that is
    still struggling the way the U.S. economy is today would require more, not less,
    government stimulus. But the U.S. federal government has used up its dry powder
    and must now withdraw much of the existing stimulus, while also cutting
    additional spending and raising taxes. This will create a huge disinflationary
    headwind for the U.S. economy that the U.S. federal reserve is already doing
    everything in its power to counteract (with a 0% policy rate and every other
    kind of monetary stimulus it can get its hands on). There is no denying that
    U.S. monetary policy has a huge influence on Canadian monetary policy, whether
    Bank of Canada (BoC) Governor Mark Carney wants to admit it or not. The BoC
    simply cannot raise its overnight rate much beyond its current level while the
    U.S. fed maintains its ultra-loose monetary policy, as it is expected to do for
    years to come.
  • Depsite my concerns about the U.S. economy, its prospects still look
    downright rosy compared to the EU’s economic outlook and more specifically, to
    the outlook for its seventeen member countries who share the euro as their
    common currency (otherwise known as the euro-zone). Deflation is a very real and
    present risk in the euro-zone and history shows a high correlation between
    European and U.S. economic activity. If there is deflation in Europe, it is only
    a matter of time before it washes up on American shores and then seeps north to

Here are a couple of other points specific to variable-rate mortgages for you
to consider:     

  • You don’t have to decide for yourself whether you can handle the risk of
    higher variable-rate mortgage payments because OSFI and the BoC now do that for
    you, with the BoC’s Mortgage
    Qualifying Rate
    (MQR) policy. It requires lenders to qualify each borrower
    using a payment that is based on the average posted rate at Canada’s largest six
    banks. Thus, if you want a variable-rate mortgage today, you have to show that
    you can afford for your payment to go from 2.60% to 5.24% (today’s MQR rate)
    over the next five years, which seems highly unlikely to me.
  • Over the past 25 years in Canada, variable-mortgage rates have proven
    cheaper than fixed-mortgage rates roughly 90% of the time. There’s always a
    chance that now might be one of those rare, exceptional times when a fixed rate
    saves you money, but your taking one-in-ten odds that you’re right.  

It is taken as gospel truth that inflation will increase when central banks
engage in money printing and that rule should rightly give pause to informed
borrowers who are considering a variable-rate mortgage. But we have never seen
the kind of monetary intervention that we are witnessing today, especially when
so many central bank policy rates are at 0% and on such a global, coordinated

Simply put, although I believe that our central bankers will eventually
create the inflation they crave,  I think the powerful countervailing economic
forces listed above will significantly delay this outcome.  

Five-year Government of Canada bond yields fell one basis point last week,
closing at 1.29% on Friday. We are now back in how-low-can-you-go territory and
five-year fixed-rate mortgages are once again widely available at sub-3.00%

Variable-rate mortgage discounts can still be found in the prime minus 0.40%
range (2.60% using today’s prime rate) and if you are the type of borrower who
is more likely to lose sleep at night worrying that you are paying too much
interest, instead of losing sleep worrying that your interest rate will rise, I
now think this is an option well worth considering.

The bottom line: I think borrowers who are currently in the market
for a new mortgage and who are comfortable with fluctuating payments will save
money with a variable rate over the term of their mortgage (as long as it is
five years or less). I also think that borrowers who already have a
variable-rate mortgage (especially a deeply discounted one) should think twice
before they convert to a fixed rate in today’s environment.

It would be easier, and less risky, for me to support the consensus view that
variable-rate mortgages aren’t worth the risk but I think it is once again time
to consider the variable alternative. This view, whether it turns out to be
right or wrong, is based on what bond market yields and a mountain of economic
data are telling me about a topic I monitor on a daily basis. Time will

David Larock is an independent mortgage planner and industry insider specializing in helping clients purchase, refinance or renew their mortgages. David's posts appear weekly on this blog (movesmartly.com) and on his own blog integratedmortgageplanners.com/blog). Email Dave

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