To Lock in or Not to Lock in? That is the Question.
Locking into a fixed-rate mortgage has been a hot topic. It’s without a doubt that since the beginning of 2022 the mortgage world has fluctuated and caused quite a stir amongst Banks, Private Lenders, Mortgage Brokers, and Mortgage holders alike. In case you haven’t heard already, the Bank of Canada has increased its prime rate twice since this past January, where it had been in a stagnant state of 2.45% since March 2020. The current Prime rate is now 3.2% and is estimated to continue to rise with the next Bank of Canada rate announcement coming on June 1st, 2022. It is important to realize that these ultra-low pandemic rates were always going to go up to pre-pandemic levels and what we’ve seen thus far is the inevitable start of the slow march back up.
Without proper context, all these conversations about rising rates may seem a little worrisome for those who hold variable-rate mortgages. In fact, if you currently have a variable-rate mortgage, the following sentence has probably gone through your mind:
“Should I lock into a Fixed Rate?”
So Should you Lock Into a Fixed Rate?
That is why we wanted to put the current rate situation into perspective and help you make more informed decisions when it comes to the most important investment you have– your home.
There are a few things to consider when deciding to lock in your mortgage or not. Although we cannot confirm that there is a right or wrong solution to the daunting question of locking in, we do strongly believe it is dependent on who you are, and what your goals are with the remainder of your current mortgage term. Our goal isn’t to tell you what to do, but to help you better understand that what you do with your mortgage is a personal decision based on your own personal comfort levels.
A good place to begin is to realize the immediate consequences of locking into a fixed rate. Such as, but not limited to, the following:
- The penalty associated with breaking your mortgage term
- The immediate payment spike
- What may be Inflation now, may also be a recession later
The penalty associated with breaking your mortgage term
You are allowed to lock in your variable rate mortgage to a fixed rate. When locking into a fixed rate, you are locking into a fixed-rate term that is equal to or greater than what is left remaining on the original mortgage term, at the time you choose to lock it in. If you do find yourself locking into a fixed rate, you must now consider the penalties associated with breaking that new fixed-rate mortgage if you should need to break it for whatever reason prior to the scheduled renewal date. Although these penalties vary not only between Lenders but also with which mortgage products you have, the industry-standard usually uses the greater of three months of interest charged on the remaining balance of your mortgage or by using the Interest Rate Differential (IRD) calculation.
The Interest Rate Differential (IRD)
There are several ways to calculate the Interest Rate Differential, or IRD. First, it uses the difference between the interest rate applied to your mortgage and the interest rate that was available when you applied for the mortgage. The outstanding mortgage balance is then calculated in comparison to the lowest fixed rate available by that lender for the term remaining when you break your mortgage and multiplied by the term remaining.
Confused yet? Well, we don’t blame you, because this is a topic rarely explained to mortgage applicants by the lenders when choosing what mortgage product is best for them. Rarely is the IRD calculation beneficial to the mortgage holder. It usually results in a large penalty payment to the lender. That is if you pay off your mortgage prior to its maturity date, or pay the mortgage principal down beyond the amount within your prepayment privileges.
The Immediate Payment Spike
To give you an example, 5yr fixed rates as of today are in the low 4% range (+/-), in comparison to most borrowers’ current variable rates of Prime minus .50% (+/-) depending on the situation. If you took a variable rate over the past 1-3 years your discount would be much greater than this. If you decide to lock into a fixed rate now, your payment will spike immediately. It will take quite a few more prime rate increases to even equal what it would be if you locked in today.
Another thing to keep in mind is whether or not your current variable rate mortgage payments are static. If they are, then despite any increase in the prime rate, your current mortgage payments would remain the same. The only difference would be the amount going towards principal and interest. If you have a variable mortgage with TD, HSBC or RBC then it is likely that your variable rate mortgage payments are static. An adjustable-rate mortgage is where payments fluctuate with movement in the prime rate. This is what most other lenders employ.
What may be Inflation now, may also be a recession later
Once the Bank of Canada (BOC) throws enough water on the current inflation fire with these successive rate increases, it will most likely have the desired effect on reining in inflation, but it will also stall the momentum gained in the economy. Many economists are already talking about the possibility of a recession on the not-too-distant horizon. Which will mean that these increases could subside by mid-2023. There will be talk of the need to decrease rates again to help stimulate the economy, and the cycle will start all over again.
Our professional opinion is that if you are able to ride out the next year’s worth of prime rate increases, then do so. It’s all about inflation now, but it may just as easily be all about recession in 12-18 months or so. The Bank of Canada will start the process of lowering the Prime rate all over again. Rising rates coupled with inflation have led most economists to expect a downturn starting in the last six months of 2023. Timing the recession won’t be easy, and a lot rests on what happens with Russia’s ongoing invasion of Ukraine.
Closing Remarks
As we said in the beginning, deciding whether or not to lock in your mortgage is a very personal decision based on your ability and willingness to pay temporary higher rates while the Prime rate increases. Static mortgage payments will not fluctuate as the Prime rate changes, the only difference will be the amount allocated to principal and interest. However, if your payments are not static, and you can withstand the current increases in the Prime rate, then it may be worthwhile to wait it out. As for the Prime rate, we expect it to rise through the remainder of 2022, but by next year, we might see the signs of change again.
Regardless, the current fixed rates are also rising and currently remain above any variable-rate mortgage rates. To lock in would mean you would be accepting an immediate payment hike in your monthly installments. Locking into a fixed-rate mortgage would also mean you would have to pay a more unforgiving mortgage penalty if you should need to break your mortgage before the end of your term. Which can become quite costly depending on the Interest Rate Differential at the time.
The best thing to do is to contact a Mortgage Professional. We can help you see what the best choice is for your current situation. If you would like to schedule a consultation, or simply want to give us a call, we are happy to help in any way we can. Even if it’s to provide a little peace of mind during these complicated times.
Contact Darcy Doyle at the Mortgage Professionals today by calling 604-889-7343 or send us an email at darcy@themortgageprofessionals.ca
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