How mortgage rates work and where they’re going next

How do I know if I'm getting the best rate?

So many factors go into rates and pricing. Calling a lender or broker and asking “what's the best rate?” is like asking a realtor “what's the best house?” There's really no right answer: the best rate, just like the best house or condo, is the one that works with your needs.

Depending on the lending product, mortgage rates can differ by as much as 1.25%. The lowest rates tend to apply to insured purchases: ones where the borrower (generally a first-time buyer) has put down less than 20% on their purchase and has to be insured against default by Genworth or CMHC (more on that here). Because the loan is insured, the lender has zero risk if the borrower defaults, which means insured buyers end up paying a premium for the risk the lender is taking.

Related info: Mortgages 101

The rate you get also depends on whether you’re looking at a fixed- or variable-rate product. Fixed mortgage rates tend to be higher because they reduce risk for the buyer but increase it for the lender. You lock into a rate for a 1 to 10 year term (5 years is the most popular) and whether the Bank of Canada rate goes up or down, you pay the same amount every month for the length of your term. That protects you if rates go up, but if they drop the way they have been lately, you’ll still be stuck paying the higher rate. And fixed-rate mortgages aren’t flexible. If you want to break your mortgage, the banks don't make it easy; you could end up paying tens of thousands of dollars in penalties.

Variable-rate mortgages typically have 3 to 5 year terms and are based on the Bank of Canada prime rate minus a percentage (e.g. prime minus 0.6%). Variable rates are lower because the risk is reversed: the borrower pays whatever the going rate is any individual month, so there’s no risk to the bank if the prime rate goes up or down. For borrowers, it’s a great deal if rates stay low or go down, but not if they go up: since you’re not locked into one price, your monthly payments will go up with a rising prime rate. However, in a low, low interest environment like the one we're in now, variable is relatively low-risk, and it can save you tens or even hundreds of thousands over the life of your mortgage.

One big benefit to variable mortgage products is that they’re MUCH more flexible. If you need to break your mortgage the penalty is minimal: just 3 months interest. With a fixed-rate mortgage, you’ll pay A LOT more.

Despite all that, the five-year fixed is the most popular option out there. But while locking in at today's low prices is certainly tempting, it helps to understand the reasons behind the popularity of this product: 5-year fixed-rate mortgages are the most profitable option for banks, and they spend a lot of money marketing them. But that doesn’t make them the best deal for the average Canadian.

How do I figure out what's right for me?

Working with someone who really knows what they're talking about is the most important thing, and that's usually a mortgage broker. I find there's often not a lot of experience at the branch level: bank mortgage specialists and advisors are more focused on selling products that profit the bank than on digging a little to get a deeper understanding of what will work best for the borrower. It’s easier just to take someone's order than to be a consultant and break down options as part of an educated discussion.

One important thing to remember when you're considering options: the lowest rate and the greatest savings over time aren't necessarily the same thing. A lot of super-low rates have a ton of conditions: things that make them good for the lender but not so good for the borrower. Opting for the lowest rate over other product features means you could be saving $30 a month or a $1 a day, but if you need to break your mortgage, it could cost you $30,000 later.

I’m not going to break my mortgage, so I don’t need flexibility - what’s my best option?

Nobody goes into a mortgage thinking they're going to break it. But a surprisingly high percentage of Canadians break their mortgages. Life happens. When you get a mortgage, you may not realize you'll be getting a divorce, moving to Hong Kong - or selling your house without buying another one. A lot of people actually end up breaking mortgages to save money. If you locked in a year ago at 3.5% and now the prime rate is almost half that, even a penalty of $15,000 or $20,000 is worth getting a new mortgage: you’ll save thousands in interest and pay off your principal faster.

It sounds like a variable rate would save me money, but I'm super risk-averse. What are my options?

If you've done your research and feel like fixed is really the way for you to go, that's fine: peace of mind is worth a lot, too. I generally counsel my clients who want a fixed-rate mortgage to go with a non-bank lender like First National or RMG, since their penalties to break a mortgage are dramatically lower.

However, I also like to offer up the idea of a “self-imposed fixed mortgage.” Basically, you get a variable-rate mortgage, but you set your payments to be what you would be paying with a fixed-rate – an additional $100 or $200 a month or whatever the difference might be. That way, you're covering yourself for a potential rate increase and paying off your principal at the same time (bonus!). So if lending rates do go up, you'll already be used to making higher payments. And if they drop (or you decide to move to Hong Kong), you can break your mortgage without a painfully large penalty.

One of the major banks also offers another variable that offers the stability of a fixed payment: regardless of any change in the prime rate, payments stay the same. The only thing that changes is allocation of your payment to principal and interest. So if the prime rate drops, you’ll pay off your principal faster, and if it goes up, more goes to interest.

Rates are super low now, but what do you think will happen to them in the next few years?

I think they’ll stay low for several more years, and here’s why. The Bank of Canada recently made an unprecedented announcement that rates are going to stay low until 2023. That's not something they've ever done before, and it’s going to instill a lot of confidence around borrowing. And there is room for rates to go even lower: if you compare us to other places like Europe, which has hit negative rates, Canada actually has some of the highest interest rates around.

Another indicator that mortgage rates will stay low? In general, bad news (high unemployment, uncertainty) keeps them down. Good news (great economy, low unemployment) means higher interest rates. However, as we all know, there’s a lot of stuff happening these days that’s not so good, and a lot of uncertainty. Unemployment is high. There's something like $10 billion in deferred mortgages out there right now, and we don’t know what will happen when that comes to an end. CERB will end too, which will impact the economy. And there’s always the chance we could face another wave that will shut everything down again.

My bank just called and offered me a new 5-year fixed mortgage at a lower rate than I was paying before - with no penalties. Should I take it?

A number of banks are currently running campaigns to lock current clients into 5-year fixed products. So if you had a 3% rate, for example, they might offer you a 2.4% blended rate. And while lower payments certainly sound great, if you compare your new payments to what you could get with a brand new mortgage, you're not doing better. In this new rate, they are simply rolling in the penalty , which means you pay more interest and less principal in the long run.

If anything, you should be breaking your current mortgage and getting a whole new one at a much lower rate instead of settling for paying a little bit less. I mean, nobody has a crystal ball, but there's a much better chance of rates going down than up and the Bank of Canada has already said we'll be where we are for at least three years. The mortgage they’re offering you is more about protecting themselves against further drops than maximizing your savings.

It all comes down to getting educated - and getting the right mortgage for you. One that will cost you the least amount of money over time, is flexible enough to adapt if life changes, and give you the peace of mind you're looking for.