5-year Variable Rates in Ontario

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A variable rate mortgage follows the Canadian Prime Lending rate which is set by the Bank of Canada, so it is volatile as it fluctuates with the market interest rate. The 5-year term is the most popular mortgage length and is a common choice amongst Canadians looking for an Ontario variable mortgage rate. The mortgage payments can be set up one of two ways:

1)      A set payment where the mortgage amount due remains constant. Within the payment itself, the interest portion fluctuates. For example, if interest rates go down, more of the mortgage payment is applied to reduce the principal, but the total outlay remains the same.

2)      A dynamic payment where a fixed sum is applied to the principal only. As interest rates change, so does the interest portion of the payment, thereby increasing or decreasing the overall mortgage payment due. For example, if interest rates go down, the total mortgage payment reduces.

Connotation

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A variable rate is usually expressed as “prime plus/minus a percentage amount”.

Example:  Assuming the current prime rate of 3.00%, we would read the variable rate “Prime -0.75%” as 2.25% (3.00% - 0.75%)

What drives changes in Ontario 5-year variable mortgage rates?

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There are various determining factors driving 5-year variable mortgage rates. One such factor is five-year government bond yields, which are determined by the Bank of Canada. The five-year variable rate changes when there are fluctuates in the Prime Lending Rate.  The Bank of Canada adjusts the prime rate depending on the state of the national economy which is determined by such factors as unemployment, manufacturing and exports. Together, these shape the inflation rate. When inflation is high, the Bank of Canada must act to avoid an over-stimulated economy. The prime lending rate will increase to make the act of borrowing money more expensive.  When inflation is low, the prime rate will decrease to stimulate the economy to improve borrowing. The variable mortgage rate is set by banks at either a discount or a premium determined by competition, strategy and desired market share.

Source: RateHub.ca averaged data from competitive mortgage brokers

Popularity

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Mortgage Chart by Popularity and Age Group:

Source: CAAMP "Annual state of the Residential Mortgage Market in Canada" 2010 

Although fixed rate mortgages make up two thirds of the market, a significant minority have variable rate mortgages. Fixed rates are also common for first-time home buyers because they look for stability in their mortgage payments. Older age groups (the seasoned home buyers) are more likely to take on the risks and select a variable rate.

Comparing Ontario 5-year variable mortgage rates

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A variable interest rate has historically proven to be lower over time, due to the premium cost of interest rate protection of the fixed rate mortgage. There are no guarantees as to which direction interest rate will move and for how long. Those averse to risk will avoid the variable rate mortgage, but for those that are comfortable with the rate uncertainty, can take on the variable rates. If the spread, between the fixed and variable rate is significant it may not worth it to opt for the stability of a fixed rate. However, most of the general public chooses not to engage in the risk of possible interest rate fluctuations, which is why fixed rate mortgages tend to be more popular.

Variable Rate Mortgage Forecast

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The Prime Lending rate is currently at 3.00% and the ten year average of prime is 4.33%. Estimates by the big Canadian banks, if accurate, predict a 4.50% prime rate by the end of 2012.

Average Prime Rate in Canada: 4.31%
Highest Prime Rate observed: 6.25% on Wednesday, June 27th 2001.
Lowest Prime Rate observed: 2.25% on Wednesday, April 22nd 2009.

Based on an 80-basis-point discount from prime [Prime -0.80], these forecasts suggest 5-year variable rates in the 3.70% range by year-end 2012. That's slightly higher than today's best 5-year fixed rates.

Source: Canadian Mortgage Trends