The Relevance (or Irrelevance) of Mortgage Rate Expectations

Variable-or-fixed-mortgage61% of Canadians expect higher interest rates one year from now. 24% believe rates will stay the same.

These stats are from a recent 1,000-person CIBC-Harris/Decima survey.

Respondents were also asked: If you had to choose between a fixed or variable-rate mortgage today, which would you select? Their answers:

  • 39% would choose fixed
  • 32% would choose variable
  • 25% were undecided

Mixed opinion/confusion about rate selection is pretty typical. Moreover, peoples’ opinions will change as rates change. If we were in the midst of rate hikes and you polled these same respondents, they’d lean more towards fixed rates (if history is a guide).

But rate expectations are just one criterion in mortgage planning—and a dubious criterion at that (because the forecasts upon which they’re based can change so quickly and drastically).

CIBC SVP, Colette Delaney, says mortgage decisions “should be based on how your mortgage fits with your long term financial goals, not on short term rate fluctuations.” And she’s right.

falling-ratesRates have dropped like an anvil. Yet, that has no bearing on rates 12 months from now. Similarly, rates 12 months from now have no bearing on rates 12 months after that.

A mortgage plan is better made by weighing the common mortgage suitability criteria. That means evaluating your 5-, 10- and 20-year financial plan, equity, job stability, projected income growth, savings, liquidity, and risk sensitivity. Generally, the more you can afford to be wrong on rates, the more you can lean towards a variable mortgage or shorter term.

Historical research and rate simulations can also help when choosing a term. For example, as most mortgage professionals know:

  • The most prominent mortgage research has shown that 77% of the time (historically speaking) a deeply discounted variable costs less than a 5-year fixed.
  • Economists believe a “normal” (policy neutral) Bank of Canada overnight target rate is in the 3.00% to 3.50% range (we’re at 1.00% today)
  • Prime rate has risen just over 3% on average in past rate cycles (See “Variable-rate payments Over Time.” This includes the economic cycles since the modern era of monetary policy [i.e. inflation targeting] began in 1991. Prime rate has already risen 0.75 percentage points from the lows of our current cycle.)
  • Going forward (apart from occasional and relatively brief rate spikes), analysts largely expect low growth, low inflation, and overleveraged consumers to keep interest rates below their long-term average.

Mortgage planners can use this kind of information to create amortization simulations. That analysis is then used to illustrate the hypothetical borrowing costs of different rates and terms.

Mortgage-Amortization-SimulationWe do simulations like this regularly and clients love them. What these models do best is quantify the potential cost differences between terms. That helps people better understand the price of certainty. (Fixed rates and longer terms provide “certainty” but come with pricier rates up-front.)

It’s vital to remember that simulations rely on assumptions. For example, not only do you have to assume rates will go up, but you have to assume when and how high. Those inputs will invariably be wrong to some degree, and the margin of error is often significant enough to make simulation recommendations invalid. As a result, rate models are always secondary criteria to the client’s financial suitability considerations and should never be relied on exclusively.

At the moment, our rate models (based on the Big 6 banks’ rate projections, historical mortgage spreads and the best rates for each term) suggest the most value lies in a 2.99% three-year fixed — available through select brokers. After that, prime – 0.90% variables and 3.59% five-year fixed terms are neck and neck in terms of lowest hypothetical borrowing cost over five years.

As an aside, people on the fence needn’t give themselves an ulcer when deciding between fixed and variable rates. Hybrid mortgages are a great solution for providing rate diversification. That’s because you can allocate any amount of your mortgage to the fixed or variable portions. For example, you could choose 67% variable and 33% fixed if you wanted to.

If you do get a hybrid, just be sure to choose equal terms (e.g. don’t get a 5-year variable with a 2-year fixed). Otherwise, the lender might stick you with a subpar rate on renewal of the shorter term.

More survey findings: Among younger home buyers (25-34 year olds), just 27% would choose a variable-rate mortgage today. That jumps to 42% in the 45-54 age category.

 Rob McLister, CMT

  1. When we first bought our house in 2002 we opted for a 5 year fixed, but since then have been variable and would never go back. The savings we have made over the past 4 years have been incredible. For the past year everyone has been chanting to get back into a fixed loan as rates were going to sky rocket. Not only have they stayed about the same but I really don’t see how they can go up tremendously when so many Canadians are in over their heads.
    my 2c

  2. The problem is that if rates stay this low for a long time, even more Canadians will be in over their heads. It’s a delicate balance.

  3. More Canadians in “over their heads: assumes that there are no people who will take advantage of the low rates to simply save on interest. Most of my clients are asking first about reducing their amortizations or how they can double up on their payments. None are expecting to go looking for a more expensive house just because I am putting them into a VIRM.

  4. Hi Rob,
    Here is some great advice for people who read newspapers.
    October 26, 2007
    Globe Says Lock In
    Rob Carrick from the Globe & Mail is ringing the alarm. With mortgage rates at 6-year highs and shrinking variable-rate discounts, he says it’s time to lock in now.
    Also back in 2007 in the Globe:
    Alex Haditaghi, CEO of, said his contacts with bank representatives suggest that fully discounted five-year rates could go as high as 6.5 per cent from their current level around 6 per cent. He also warned maximum discounts on variable-rate mortgages may shrink further. “Two banks have given the heads-up that if you want to lock up your clients, do it now because by Nov. 15 you’re going to see us go to 0.5 below prime.”
    I wonder how these people are doing today?

  5. With all due respects to Collette Delaney, banks don’t want to see clients in variable rates because they cost more than fixed rates… do the math… More and more they are forced to discount the variable and loose money to face the competition

  6. We have to remember as well, that when getting a variable mortgage you are qualifying at the Bank of Canada posted, which today is 5.39%. I always coach my clients to make the extra payments now while rates are low. So, it’s difficult to get over your head.

  7. I’m sure many people are using this opportunity to pay down debt, but many others are using low interest rates as a way to buy more house than they otherwise could afford. Are monthly payments not an important factor for prospective buyers in deciding what to spend on a home?

  8. Not to sound too ego-centric, but what difference does it make to you if “even more Canadians will be in over their heads,” as long as YOU (oneself) are not among these Canadians. The savvy individuals will take the opportunity afforded by low rates to pay down their own mortgage/debt, irregardless of how irresponsible other Canadians might be. On an individual level, a low interest rate is not a problem (for the borrower). Oversimplified, but you know what I mean.

  9. My only problem with mortgage lender’s websites and some of these articles that go out to the public is that they never mention anything about stress tests.
    Perhaps the mortgage industry (and FIs) should also educate & provide to potential homeowners with stress tests. A tool to show the effect of rising interest rates and their mortgage payment.
    In the commercial world, we (as a Lender) do stress tests and use that to show management how much vacancy, interest rate increases, etc. a loan can tolerate before hitting payment problems.
    We just don’t do this for the consumer side. The mortgage industry just brushes off responsibility and says “it’s the consumer’s choice and responsibility”. And you wonder why some say that all brokers and FIs are only interested in their profit.

  10. Hi Mark,
    Stress testing is an essential and normal part of mortgage planning. Most mortgage professionals use internal spreadsheets or calculators for this purpose and then share the results with their clients.
    While we’re not able to reference stress testing in every article, much has been written on the subject. You can find related articles by using the search feature above.
    As a side note, your idea of a stress testing tool is a good one. We’ll definitely work on it.

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