Adjustable vs Variable Rate Mortgages

Latest News Victor Anasimiv 17 Jul

Last week the Bank of Canada finally did what prognosticators in the media have, for years, been unsuccessfully predicting.  They raised interest rates.  More specifically, they raised their ‘overnight’ rate by 25bps – 0.25% or a 1/4 point. The ‘overnight rate’ is the interest rate at which major financial institutions borrow and lend one-day (or “overnight”) funds among themselves. As expected, all banks, credit unions and monoline lenders have raised their prime lending rates by 0.25% to 2.95%.  TD is the outlier here – their prime rate now sits at 3.10%, although they do offer slightly deeper discounts off their prime rate.

Interest rates have been at historically low levels for many years now with nowhere to go but up, so this slight increase shouldn’t be much of a shock.  The key word here though is “slight”.  If one were to base their views on media stories alone, one would probably think the sky is falling and that they are in serious risk of defaulting on their mortgage.  That could not be further from the truth.  While it is true that keeping one’s indebtedness as low as possible is a good thing, it’s important to understand exactly what this recent change means for your mortgage.

If you have a fixed rate mortgage, this change in prime rate means nothing to you.  Your interest rate remains the same until the end of your term.

If you have a variable rate mortgage, what happens depends on whether your mortgage is a true variable rate, or an adjustable rate.  Lenders can use these terms interchangeably, which can create some confusion, as there is a difference.

If you have a true variable rate mortgage, your payment will actually stay the same.  What does change is the proportion of each payment going towards principal vs. interest.  With this 25bps increase, on average, for every $100,000 you owe on your mortgage, about $20/month more of your payments will be going towards interest.  This will slow the rate at which your amortization decreases.  TD & most local credit unions generally follow this rule.

If your mortgage is what is known as an adjustable rate mortgage, your payment will increase as the lender’s prime rate increases.  With this 25bps increase, on average, for every $100,000 you owe on your mortgage, your payments will increase about $13/month.  Examples of lenders who follow this rule include First National, RMG, Scotiabank & Street Capital.

If your mortgage is of the former variety and you would like to keep your amortization decreasing as per usual, consider using your pre-payment privileges (standard with most mortgages) and increasing your payments by that magic number of $13/month for every $100K owed.  Or better yet, bump your payments up as high as you can afford – this will give you a bit of a buffer for any future rate increases, and you’ll be paying your mortgage down faster.

The important take away from all of this?  DON’T PANIC.  It’s always a good idea to keep a tight handle on your finances and make sure you’re on the right track.  But now is not the time to abandon your variable rate and lock into a fixed.  While it’s impossible to accurately predict what the banks will do in the future, the appetite for another rate increase is minimal.  The variable rate option is still a desirable one.

For more information on how this change affects an existing mortgage, your first step should be to check your online banking if you have it set up or contact your lender’s customer service department.  We would be happy to help track down the necessary info for you, crunch some numbers more specific to your current or anticipated mortgage situation or answer any other questions you might have.  Please let us know how we can help