I keep hearing interest rates may rise. What would that mean for my mortgage?

FPAC response: 

As you’ve heard, the Bank of Canada recently announced it would be ending its “quantitative easing” program, the government bond purchasing program that contributes to keeping interest rates low. 

The end of quantitative easing means that the bank is expecting to increase its policy interest rate—which means that variable interest rates from mortgage lenders will rise in turn. (Fixed mortgage rates are based on long-term bond rates, while variable mortgage rates are based on the Bank of Canada’s policy rate.)

Currently, the Bank of Canada’s policy interest rate is 0.25%, and it may increase multiple times over the next few years. Each increase is typically 0.25%, although bigger jumps aren’t out of the question. Numerous interest rate hikes in the coming years might bring rates for variable mortgages from about 1.45%, where they are now, to 3.45% or so in a few years, when you’re ready to renew.

If variable mortgage rates are expected to rise, to answer your first question—whether to keep your variable mortgage or lock in your mortgage rate—we need to weigh whether or not you might save money if you lock in your mortgage at the current three-year fixed rate.

The current three-year fixed rate ranges from about 2.49% to 2.79%, which is still relatively low compared to historic rates. If variable rates rise above the fixed rate that you could lock in at today, then based on the math alone, it appears there may be cost savings to locking in at a fixed rate. 

However, this issue is a bit more nuanced than the simple math. Here are a few thoughts to help you think through this carefully.

Is this your primary residence or a rental property? 

This question is essential because it considers your cash flow and your ability to meet your payment obligations. I’ll address considerations if it’s your principal residence below, but first, let’s run through the issues assuming it’s a rental property.

Assuming this is a rental, are you currently cash-flow positive, negative or even neutral? If you are currently cash-flow neutral, a rate increase will push you into negative territory—is your personal cash flow able to handle that deficit? 

If not, I might consider locking in if you plan to hold this property past the three-year mark. (Keep in mind that it’s possible to be cash-flow negative month-to-month but return to positive once you file your taxes and deduct all related expenses.)

If this is a cash-flow positive rental property, is your lifestyle dependent on the income generated by this property? If so, will your lifestyle be severely affected by this income reduction? If so, then I would suggest you lock in your rate.

What’s your short-term plan for this property?

This is a more straightforward question to answer. If you plan to keep the property—either as a rental property or principal residence—past the three-year mark, locking in your rate can be good. If rates rise as expected, you’ll save more compared to keeping your variable rate.

However, if you’re considering selling this property within the three-year term, I recommend keeping your variable rate. The main reason is that the penalties for breaking your fixed-rate mortgage will be much more than you will save by locking in your rate. 

The penalties for breaking a variable rate mortgage are usually limited to three months’ interest, and this limit will work in your favour even if rates rise over the next three years. The penalties for breaking a fixed-rate mortgage, in contrast, are calculated differently and are often much higher. 

How will a rate increase affect your budget?

Now let’s consider a rate increase if this is your principal residence. For many people, mortgage payments make up a huge portion of their household budget, leaving them with very little or no discretionary income. 

If this is you, then locking in your rate might be a good idea. As the overall cost of living increases due to inflation, there is comfort in knowing that at least one portion of your expenses is locked in for at least three years—or more if you lock in for longer.

Suppose you have enough “wiggle room” in your budget to absorb an increase and not impact your lifestyle. In that case, there’s a chance you could save money by staying on a variable rate if rates don’t increase or if they increase by smaller amounts or at a slower pace than expected. 

For years, there’s been speculation that rates would go up, but this hasn’t happened yet, and those who have been on a variable rate for the past five years have saved thousands. However, just like investing, past performance is not a guarantee of future results. Just because it hasn’t happened yet does not mean it will not occur in the future!

What happens when your mortgage term expires?

Finally, let’s turn to your question about what happens in three years when your current mortgage term expires. 

There is a strong chance that when your current term expires, you will be renewing it at a much higher rate than you are paying right now. If this is a concern, and you’ve worked through the other issues I’ve raised, you could consider locking in for five years—or even longer—for better peace of mind. The only thing you would lose is flexibility should you need to break your mortgage before your term expires. 

As you can see, the answer to your questions all depends on your financial situation and your ability to handle any significant increases. It’s crucial to ensure you’ve considered all the issues noted above before making your final decision.

This response was provided by FPAC Associate Member Seun Adeyemi, BA, CKA, CFP, a Certified Financial Planner with True Wealth Advisors in Whitby, Ontario.

Qualified Advice is written by members of FPAC (the Financial Planning Association of Canada), a MoneySense content partner. Working closely with governments, regulators, financial planners, academia, vendors and the general public, FPAC’s goal is to set standards and principles that will allow financial planning to evolve into a knowledge-based profession that ultimately commands the credibility, public awareness and respect afforded to other advisory professions. 

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More on mortgages:

• What is a mortgage?
• Understanding mortgage affordability calculators

• Homebuyers: How large should your downpayment be?