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As variable rates rise, is it time to lock into a fixed-rate mortgage term?

The last year and a half has been a rough time to be a variable-mortgage holder. The cost of borrowing has ballooned just shy of 5% since March 2022, when the Bank of Canada kicked off its steepest tightening cycle in its history. As a result, its benchmark Overnight Lending Rate – which is used to set the Prime rate in Canada and, by extension, lender’s variable mortgage rates – has increased from its pandemic low of 0.25% to 5% today. The central bank’s latest 0.25% rate hike on July 12 likely pushed affordability to the brink for many borrowers, as lenders baked that quarter-rate increase into their pricing, marking a cumulative 4.75% increase since rate hikes began. The lowest five-year variable rate today is now 5.95%, compared to 5.8% back in June, and up from the all-time low of 0.85% at the start of 2022. 

Also read: Home affordability worsened in June as rate hikes took hold

Let’s take a look at how costs have changed if, for example, you took out an adjustable variable-rate mortgage back in March 2021, with the following criteria:

  • A purchase price of $1,500,000 with 20% down = a total mortgage amount of $1,200,000
  • A variable rate of 1.5% (available at the time)
  • A five-year term 
  • A 30-year amortization

Following the BoC’s 10 rate hikes,  your rate has now increased to 6.25% as of July 2023. Over your term, your monthly payments have surged by over $3,000, from $4,139 to $7,178. You now have a remaining mortgage balance of $1,142,896 and are wondering: should you stick with your existing mortgage for the remainder of your term, or is it time to make the move to a fixed rate?

The best strategy comes down to your personal risk tolerance, and whether or not you believe mortgage rates will continue to rise for the remainder of your term. Let’s crunch the numbers to explore what options are available.

Scenario 1: You believe rates will continue to rise

If you think the Bank of Canada will continue its hiking cycle and are looking to get out of your existing variable-mortgage term, you generally have two options:

  • Break your mortgage and refinance with the best five-year fixed rate you can get from a new lender

  • Convert your existing mortgage into a new five-year fixed-rate term from your existing lender*

Both methods come with their own considerations.

OPTION 1: Refinancing your mortgage will mean you need to pay a penalty of three month’s interest, which will increase your overall mortgage amount. You’ll also need to shop for a new rate, re-pass the mortgage stress test, and go through the process of qualifying with a new lender. You can re-extend your amortization back to the original 30 years (thus lowering your monthly payments). You can also take out some of the equity already in your home. More importantly, you’re more likely to score a lower rate if you go through the trouble of making the switch.

Check out our Mortgage Penalty Calculator to see what it would cost to break your mortgage.

OPTION 2: Switching to a fixed rate with your existing lender is typically the most convenient, as you usually won’t need to re-qualify, you can arrange for the switch with a simple phone call, and you’ll remain on your existing amortization schedule, with 28 years left to go. However, the rate you’re likely to receive will be far from the best on the market; as your lender knows they already have your business, they have no incentive to offer you a deal, and the rate you receive will be closer to their posted-five-year fixed rate, rather than a discounted option. You’ll also normally have to lock into the fixed rate for a full five years instead of the remaining time on your current term.

Let’s take a look at how the numbers play out :

Mortgage amount: $1,142,896 OPTION 1
Refinancing with a new lender
Converting to fixed with current lender
Mortgage rate 5.79% 6.64%
Penalty $17,858 $0
New mortgage amount $1,160,754 (includes penalty) $1,142,896
Remaining amortization 30 28
Monthly payment $6,752.75 $7,454.52
Total payments $405,165.00 $447,271.2
Total principal paid $84,409 $86,570.14
Total interest paid $320,756 $360,701.06
Balance as of July 2028 (end of new 5-year term) $1,076,345 $1,055,024.87

Takeaway: For borrowers seeking monthly payment relief, this refinancing scenario would be the way to go, as they’ll be paying $701.77 less each month compared to if they converted their mortgage, and $425.25 less than their current monthly payment. They’d also pay $42,106.20 less overall over the course of the five-year term, including $39,945.06 less in interest than if they converted.

However, factoring in the penalty incurred by breaking the mortgage to refinance would increase the total mortgage amount to $1,160,754. They’ll also be paying down the mortgage for an additional two years with a new 30-year amortization, and have an additional $21,320 left on their principal mortgage amount than the converting scenario. However, it’s important to keep in mind that refinancing an existing loan can also free up more equity to be accessed as cash – a total of $27,420 in this scenario, according to our Refinance Calculator.

*Borrowers should also note that, depending on their mortgage product and type – such as “no-frill mortgages” – their lender may not offer the option to convert into a new fixed rate at all, or only offer fixed rates at specific terms which would require you to lock into the fixed rate for longer than the remaining time on your current term.  Some banks and lenders may also only provide fixed rate options that are higher than their posted rates. There may also be additional fees – such as administration, lawyer, and discharge fees – that the borrower will need to pay.

Scenario 2: You think mortgage rates will be cut during the remainder of your term

OPTION 3: Sticking it out with your current variable-rate mortgage might not be such a bad idea if you think rates will be coming down again. While the Bank of Canada has been steadily raising rates since March 2022, analysts are cautiously optimistic that it may be nearing, or has reached, the end of its cycle, and are increasingly expecting that rate cuts may occur as early as March 2024.

So, with this in mind… should you stick with your existing rate?

While we can’t predict when or if the BoC will cut its rate, let’s theorize that rates will indeed come down by 1% over the remaining three years of your term (let’s say 0.5% in July 2024, and another half-point in July 2025).

Option 3: Sticking it out with your existing variable rate

Mortgage rate: 5.75% as of July 2024 (assuming 0.5% drop in prime) and 5.25% as of July 2025 (assuming another 0.5% drop in prime).
Monthly payments: Lowered first to $6,836, and then down to $6,511
Renewal date: March 2026
Total payments as of 2026: $367,934
Total principal paid as of 2026: $107,348
Total interest paid as of 2026: $260,586
Remaining balance as of 2026:  $1,092,652.32

Should that be the case, your monthly payment would be lowered first to $6,836, and then down to $6,511. Your term would end in March 2026 as originally planned, with a remaining balance of $1,092,652.32. 

The takeaway: In this scenario, you’d still be paying more per month than if you had refinanced your mortgage, though you’d pay less than if you had converted. However, if you stick it out, you would be up for renewal sooner, in 2026, (vs 2028 if you refinance or switch to a fixed rate now) giving you the freedom to switch to a fixed rate or even refinance without penalty two years earlier (at your renewal time).

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The bottom line

For existing variable-rate borrowers looking to avoid further rate volatility, and who believe mortgage rates will keep rising, refinancing or converting your mortgage to a new five-year fixed term may provide significant savings, stability, and even some payment relief. However, it’s important to note that each borrowers’ financial situation varies which can impact the options available to them – for example, someone looking to refinance a mortgage on a rental property would be offered higher rates than someone who uses the home as their principal residence. It’s always a great idea to work with an expert mortgage broker, who can help you run the numbers as well as navigate the rate marketplace, to help you find your best course of action.

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