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15 Mar

Fixed Rates versus Variable Rates

General

Posted by: Sarah Boudreau

The Bank of Canada announced a 50bps cut to the overnight rate on Friday at an unscheduled meeting. The overnight rate, or policy rate, can have an impact on the Prime lending rate at the banks, as we saw 2 weeks ago at the BOC’s regularly scheduled meeting. The banks have not responded to this second cut yet, and we are not sure if or by how much they will correspondingly reduce the prime lending rate. It is unlikely to be a full 50 bps. Furthermore, there is another scheduled meeting in April, and many economists are expecting another drop in the overnight rate. This also may or may not drive the Prime rate down further. Changes to the Prime lending rate impact variable rate product borrowers and credit line holders.

Variable Rate Mortgages:

A variable rate mortgage product is issued with a set differential to the prime rate for a specific period of time (ie: Prime less 0.60% for a 5 year closed term). This means that with changes to the prime rate, your monthly payment (sometimes) and overall cost of borrowing fluctuates. Home Equity Credit lines are similar, however they are usually priced at Prime PLUS a differential, have no set term and require interest only payments (no amortization).

The prime lending rate may go down, but the differential (the set discount to prime over a 5 year closed term) offered for new mortgages is, and will likely continue go up in the short term if the Prime lending rates continue to fall.

In my opinion, waiting to see if the Prime rate falls again BEFORE you secure a variable rate mortgage product does not really benefit you, unless you time this absolutely perfectly.

Fixed Rate Mortgages:

A fixed rate mortgage term is issued with a guaranteed rate, payment, and cost of borrowing for a set period. The most common period is 5 years. 5 year fixed mortgage rates are impacted in most part by the 5 year bond rate, along with a few other factors related to the lender’s cost of doing business. I will get into that another time. The sharp 5 year fixed rate drop we had last week was a quick response to corresponding bond yields. Almost as quickly, many lenders who dropped their 5 year fixed rate, have already gone back up slightly.

In short, my recommendation is that if you are considering a new purchase within the next few months, getting pre-approved and securing a “ceiling” rate right now would be a good idea. If you have been thinking about an early renewal to take advantage of new lower fixed rates, you should be calling your mortgage advisor ASAP. 

Here is a short glossary of some of the other “interest” terms you might be hearing about in the news:

Benchmark Rate:  The Bank of Canada conventional 5 year rate. This rate is meant to be a cross-section of posted bank rates. Historically much higher than contract rates available, this rate is used in qualifying applicants.

Contract Rate:  The actual interest rate that the mortgage holder pays.

Overnight Rate:    The interest rate at which major financial institutions borrow and lend one-day (or over-night) funds among themselves; The Bank sets a target level for that rate. The target for the overnight rate is often referred to as the Bank’s Policy Interest Rate.

Prime Rate:   The annual interest rate that Canada’s major banks and financial institutions use to set interest rates for variable loans and lines of credit.

Qualifying Rate:   The rate used by mortgage stress tests to determine an applicant’s affordability. Typically the benchmark rate, or the contract rate plus 2%

 

As always, do not hesitate to call or email if you have questions.

Sarah