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Locking into a short-term fixed rate can be a helpful strategy for homeowners looking to renew, experts say.
Will I be able to afford my mortgage when I need to renew? It’s a big concern. The Bank of Canada’s eight rate increases in less than a year has been historic and has had a significant impact on people being able to make their payment. Currently, variable rates are sitting above six per cent and five-year fixed rates are in the high four to five per cent range. That’s the harsh new reality facing over 1 million Canadians who will have to renew their mortgages this year.
Economists predict the Bank of Canada will begin to lower the overnight lending rate in early 2024, potentially even as early as late 2023. But the Bank of Canada won’t lower the overnight lending rate quickly. While the five-year fixed rate has already dropped in the last few weeks, it will be some time before variable rates, which move in line with the policy-rate changes, drop drastically enough to make it an attractive option, experts say. For now, fixed rates are lower than variable rates and the risk of moving to a variable rate that could remain elevated for at least another year isn’t worth it for many homeowners.
It’s the strategy a lot of people are taking to lock into a lower per cent fixed rate for two or three years and ride it out instead of the five-year variable rate of six per cent and gambling if the Bank will drop the rate. The Bank won’t drop the rate as quickly as they increased it. At the end of the day, it comes down to people’s risk tolerance. After a year of instability in the real estate market, many homeowners want to choose a safer option with a short-term fixed rate.
Homeowners who have a five-year fixed mortgage rate up for renewal also need to understand the calculations. There’s a common misconception made with many homeowners thinking their payments will double if the rate is doubled, but that’s not true. For example, if someone bought a house five years ago and had a mortgage of $500,000 with an interest rate of 2.5 per cent and 25 year amortization, their monthly payment would be around $2,240. Five years later the homeowner would have paid around $76,000 of their principal payment making their mortgage $423,000, and the new amortization would be 20 years. With the new interest rate at five per cent their mortgage payment will increase to $2,780 per month. It’s over $500 more a month, but it’s not double the payment.
If having to pay an extra $500 more is an issue, you need to look at your budget and adjust where you spend your money. If it is still an issue then it’s possible to refinance. If the homeowner decides to refinance — when you renegotiate your existing mortgage loan agreement — then you can extend the amortization to lower the monthly payments. Typically legal fees are associated with refinancing. It’s important to refinance at maturity — when the mortgage is up for renewal — because if you break the contract beforehand it will result in penalty fees.
Understanding the different categories of where you spend can make it easier to figure out what areas in your life can be scaled back, such as food and entertainment. But for many people it will be a tough year or two ahead, experts say. Some people may be really experiencing a cash flow crunch.