Getting the Most out of Your Mortgage

By Jonathan Chevreau

Rock-bottom interest rates are as low as anyone could have expected to see in their lifetimes and with central banks around the world promising rates will remain “lower for longer,” home buyers can save even more by staying flexible with variable-rate mortgages. As long as Covid-19 is in the picture, it’s reasonable to expect overnight rates will remain low for the foreseeable future.

In mid-September the U.S. Federal Reserve said overnight rates won’t be raised before 2023.And Bank of Canada governor Tiff Macklem said in July that Canadians can count on mortgage rates not rising until at least 2023. “That’s a pretty strong indication that low rates are here to stay, at least for a few years,” says fee-only financial planner Jason Heath, managing director of Toronto-based Objective Financial Partners.

In Canada, fixed and variable rate mortgages are being offered at less than 2%. As of August, variable rates had fallen to 1.8% and six-month rates to 2.99%, according to Adrian Mastracci, fiduciary portfolio manager at Vancouver-based Lycos Asset Management.

What’s striking is the small difference in fixed rates: one-, two-, three- and four-year fixed rates are all around 1.89% but even locking in for longer still entails a relatively low rate: 2.69% for seven years and 2.99% for 10 years.

Over the past 40 years a variable rate mortgage has almost always been better during any five-year period than a fixed rate mortgage, Heath says. “It makes sense, because with a fixed rate, you’re paying extra for the security of rates not rising.” Heath says there is still room for rates to fall, “as there are places in the world where mortgage rates are under 1% and plenty of uncertainty with a potential second COVID-19 wave.” 

While the arithmetic suggests gambling by sticking with a variable rate remains the optimum strategy, new homeowners worried that this trend will eventually reverse should be aware they can buy a bit of “insurance” by considering slightly higher fixed-rate mortgages. 

Phil Soper, president and CEO of Royal LePage, recalls the early 1980s, when mortgage rates were over 20%. Even so, personally he says he always had a variable-rate mortgage “because the historical math has worked out so well: 85 to 90% of the time period variable has been cheaper.”

There are generational differences in willingness to stick with variable rates. Soper says baby boomers have small mortgages or have already paid them off, so “why have a bunch of risk on the mortgage?” But young people with huge mortgages “can roll the dice by staying variable and be right more often than wrong.” 

With these historically low rates it’s tempting to buy more home than you can afford, or to feel in no rush to pay off a mortgage. However, the pandemic has also revealed the dangers of taking on too much debt. The best (and lowest risk) investment remains paying off debt, especially as interest on residential mortgages is not usually tax deductible. 

Lethbridge-based fee-only planner Robb Engen, of boomerandecho.com, says he’s always believed in choosing either a five-year variable, or a one- to two-year fixed rate, whichever is cheaper. “That strategy has seen me bounce around between a five-year variable in 2011, a two-year fixed in 2016, and another five-year variable in 2018. My current variable rate is 1.45%, so I'd say that strategy worked out well this time around.”

Whichever route you choose, it’s never a bad strategy to pay down your mortgage as quickly as possible, thereby minimizing the amount of interest you’ll have to pay over a homeowner’s lifetime. That was the route taken by author Sean Cooper, who paid off his first home in his early 30s and wrote a book called Burn Your Mortgage. “Being able to lock in your mortgage for five years with fixed-rate mortgages at record low mortgage rates is quite tempting.”

On average, homebuyers break their mortgages after three years, generating hefty charges for fixed-rate mortgages even at today’s low rates. With variable, the charge is usually three months’ interest. 

Why do so many Canadians break their mortgages? There are many reasons, among them the need to pull out equity for investing, renovations, funding a new business, divorce, death, job loss or the sudden need to sell your property.

Although mortgage rates may not be in our personal control, it’s also important to consider how they affect home prices. Low rates let you borrow more. The more you can borrow the more you can spend on a home. “The more that people can spend on homes the more they'll upgrade, the more they'll outbid each other, and the more they'll drive prices higher. Low rates are one thing but low and falling rates are the most impactful,” says Robert McLister, Mortgage Editor of Rates.ca.

Before deciding how much home you want and what kind of mortgage to commit to, it’s wise to do some research and seek out the advice from a professional. Fortunately, there are various online tools that can help you decide if you’re financially ready for a home purchase and assess how much mortgage debt you can comfortably carry, such as TD’s Mortgage Affordability calculator.

Jonathan Chevreau is founder of the Financial Independence Hub, author of Findependence Day and co-author of Victory Lap Retirement. He can be reached at  jonathan@findependencehub.com