Bank of Canada is expected to raise overnight rate by 0.75%. Is it time to switch to a fixed rate?

Everyone predicts a 0.75% rate hike from the Bank of Canada on Wednesday. If the forecast is true, we’ll see the largest rate increase since 1998.

As a result, the central bank’s overnight rate will go up to 2.25%, and a prime rate (affecting variable-rate mortgages and lines of credit) – to 4.45%. The last time a prime rate exceeded 4% was back in 2008.

Experts believe that with an extremely high inflation of 7.7%, the BoC doesn’t have a choice but to act aggressively at its next meetings to weaken consumer expectations of a long-term high inflation.

Such moves are pushing variable mortgage rates up, and some homeowners may start wondering if they should switch to a fixed rate before interest rates grow even higher.

However, the fact that variable rates are going up doesn’t mean switching to a fixed one is a 100% great decision.

According to a spring report from the Canada Mortgage and Housing Corporation (CMHC), 53% of Canadians chose a variable-rate mortgage in the second half of 2021, marking a significant increase from 34% seen in the first half of the previous year. The report says although the tendency continued into this year, it has plateaued amid growing interest rates.

There’s good news for homeowners who are thinking about switching to a fixed rate: there’s no penalty for that. Nevertheless, in this case the homeowner must remain with their current lender and accept a much higher fixed rate offered by their lender. You don’t get to shop around, so you call your lender and accept what they offer.

Another important thing to remember is that when switching to a fixed rate, you must convert to a term that’s either equal or greater to the remaining period of your mortgage term. For instance, if you have three years left on the mortgage term, you will have to switch to at minimum a new three-year term or choose a new five-year fixed-rate term.

As mortgage rates keep growing, the difference between variable and fixed rates has also been rising, the CMHC report shows. Today’s best five-year variable rates can vary from about 2.60% to 3.35%. Meanwhile, five-year fixed rates now vary from 4.39% to even 6%.

Obviously, people are nervous. No one wants to deal with uncertainty at such a price. However, most clients still prefer variable rates. The main reason is the fact that variable rates remain lower than fixed ones, and some economists don’t believe the BoC will keep interest rates high for a long time.

From historical point of view, variable rates are often cheaper. In addition to it, a cycle of hikes is usually followed by a pause and then by a potential decline. If you already have a variable rate mortgage, calculate what your payment could hypothetically be if you had a fixed rate, and then start making such payments. This way more money will go towards the principal payment, and if variable rates go up, this additional cushion is already built into your budget.