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Variable-Rate Payments Over Time

Monthly payments on most variable-rate mortgages fluctuate when prime rate goes up or down.  It’s interesting to see how these payments have changed over time.

We created the chart below to show what one’s mortgage payment would have been had they taken out a variable-rate mortgage based on prime—any time in the last 18 years.

The chart goes back to 1991 and assumes a $100,000 mortgage with a 25-year amortization. (The data is linear so payments on a $300,000 mortgage, for example, would be three times higher than those in the chart.)

The blue line shows how monthly payments have changed with prime rate. 

The red line is the average monthly payment over the preceding five years.

Some points of note:

  • Prime rate has dropped 10% since 1991
  • 1991 is a relevant starting date because that’s when the Bank of Canada adopted explicit inflation reduction targets–a turning point in Canadian monetary policy.
  • Since then, there have been three major prime rate cycles (occurrences where rates had a sustained rise of at least 2%)
  • The average increase in prime rate (from trough to peak) was 3.16%
  • After each low (trough) was made, the average rate over the next five years was 1.23% higher.  In other words, if you picked the worst possible time to get a variable-rate mortgage, your rate over the next five years would have averaged just 1.23% more than the rate you received on closing day—far from catastrophic.)
  • The biggest prime-rate increase started in March 1994 when prime rose 4.25% in 12 months. If you had a $100,000 mortgage at prime back then, your monthly payment would have risen from $610 to $877 (a 44% increase).

The chart is a good approximation of payments, but it’s not exact because it doesn’t reflect repayment of principal.  (That would have been too hard to show in a single graph.)  Moreover, the findings here are anecdotal because there aren’t enough samples to draw statistical conclusions.

Nonetheless, it’s clear how the economy and the Bank of Canada have impacted mortgage costs these past two decades.  As we move out of our current recession, it’s not unreasonable to expect rates could rise at least 2-3%, like they have in the past.

The real takeaway here is that rates can, and do, go down after going up.  So, even though variable-rate mortgagors may feel some pain as rates rise for a few years, the pain has been more than tolerable when viewed over historical 5-year spans.

Does this mean you should jump right into a variable and tell your lender where to stick their 5-year fixed? 

No. It doesn’t. 

It’s still critical to choose a term geared to your financial resources and risk tolerance. There’s always the chance that rates exceed historical norms. Moreover, 5-year fixed mortgages at 4.25% may cost less over five years if rates rise over 2.50% and stay there for a while.

But, at least you now have more context to judge whether it’s worth paying an additional 1.70%+ for today’s 5-year fixed mortgages.


Sidebar:  Here’s a longer-term view of prime rate back to 1951. Fortunately, modern monetary policy has greatly reduced the chances of cataclysmic rate increases, like those seen in 1981.

(Source of chart data:  Bank of Canada)