Should I lock into a fixed rate mortgage with another hike on the horizon?
Soup or salad? Butter or margarine? Fixed or variable? There are many choices we have to make in a daily basis. Some are simple, while others...not so much. The decision of choosing a fixed versus a variable rate mortgage is something homeowners grapple with everywhere. With an interest rate hike widely expected next spring, should you lock into a fixed mortgage? Let’s take a look at some things to consider.
The spread between fixed and variable
Before deciding to lock in, it’s important to consider the spread between fixed and variable mortgage rates. At the time of writing this article, the lowest variable mortgage rate is 1.88 percent, while the lowest five-year fixed mortgage rate is 2.64 percent. Prime rate would have to go up quite a bit for the variable rate to be more costly than the fixed rate. We’d need to see four interest rate hikes of 25 basis points for the variable rate to reach 2.88 percent and be higher than the fixed rate.
A lot of what the Bank of Canada does with interest rates has a lot do with the Federal Reserves in the U.S. With the Federal Reserve aiming to increase interest rates three times in 2018 and the Bank of Canada lagging the U.S., we’re only likely to see one or two interest rate hikes next year. And even if those do happen, as shown in the above example, the homeowner with the variable rate mortgage will be better off.
But that being said, if interest rate hikes keep coming and we see two in 2018 and two in 2019, then that’s when it can make sense to lock in. Unfortunately, we don’t have a crystal ball, so it’s important to watch what the Bank of Canada does carefully to see if they’re hinting at a rate hike in future months and years.
When else should you lock in?
If you’re a first-time homebuyer, locking into the safety and security of a fixed rate mortgage makes a lot of sense. Your mortgage payments will be fixed. You won’t have to worry about them changing during the term of your mortgage. This makes budgeting a lot easier. Homeownership comes with a lot of expenses. You don’t want to accidentally underestimate one of them and find out that you’re house rich and cash poor with little money to save, let alone have fun.
Beware of the conversion rate
If you already have a variable rate mortgage and you’re thinking of locking in, there’s something you need to be aware of. Although variable rate mortgages let you lock in to a fixed rate mortgage at any time, that flexibility comes at a cost.
When making the switch from variable rate to fixed rate, you aren’t likely to get your lender’s best mortgage rate. You’ll get something known as the conversion rate. This is the rate lenders offer to borrowers when making the switch from variable to fixed. This may be almost as high at the posted rate, so definitely consider this carefully before locking in.