Variable or fixed mortgage in 2024? Which is right for you? 

To help determine this, we will look at:

• The difference between variable vs fixed mortgage rates.
• Why the variable rate has increased after the 2024 rate pause (Updated April 2024)
• 5 Reasons why a variable rate could lead to more savings for years to come, including:
  • Historical, long-term evidence of variable rate cost savings. 
  • When the variable rate should stop increasing, and when it’s expected to drop. (Updated April 2024)
  • How to minimize the risk associated with a variable rate mortgage.
  • How variable rates offer more flexibility and lower penalties than fixed rates. 
  • How to time a fixed rate lock-in. 
• Why a fixed rate mortgage will be the best path for many. (Updated April 2024)
  • Review and benefits of a 2-3 year fixed rate.
  • Review and benefits of a 5 year fixed rate.
• The best questions and personal considerations to help determine your best rate strategy.

Variable vs Fixed Mortgage Rates: Features Compared

The short video below will simplify the variable vs fixed mortgage rate differences and provide a good basis for our discussion.

To summarize:

Fixed Rate:

• Locks your rate into place for a period of time called the term (usually 1,2,3,4 or 5 years).
• Rate is typically a bit higher, but provides for a stable, consistent mortgage payment for years to come.
• If you break the mortgage, there is often a bigger penalty called an ‘Interest Rate Differential’ penalty.
• Switching from a fixed rate to a variable rate without breaking the mortgage is impossible.

Variable Rate:

• The rate floats or changes over time, with decisions from the Central Bank of Canada.
• The rate is determined using a discount off of the Prime Rate (ex. Prime minus .50%).
• Typically, the variable rate is lower than fixed, but can also float higher for periods. 
• If you break the mortgage, the penalty is typically far lower.
• You can lock the variable rate into a fixed rate at any time, without breaking the mortgage.

Variable Mortgage vs Fixed: 5 Reasons Why Variable Could be Better in 2024

Variable is Historically and Statistically Shown to Cost Less than Fixed

According to a 2001 report completed by Moshe Milevsky, Professor of Finance at York University Schulich School of Business, variable mortgage rates beat 5 year fixed rates 70% – 90% of the time. 

Using data from 1950 – 2000 the study includes a period of high market volatility, not unlike what we are witnessing in 2022 – 2023, in the 1980s and 1990s when mortgage rates were much higher than they are at present. This means that the data used in this study is not selected during a period that would manipulate the results to favour a variable rate over a fixed rate. 

I believe it’s quite the opposite. I believe that the rate volatility in the 1980s and 1990s skews the argument more toward fixed rates, and that it is more likely for rates to remain lower over the long term than the peak rates seen in periods of high inflation. 

With this said, in the author’s words “When interest rates are at low levels, one is better off locking in at long term rates”.

To summarize, the author of the study suggests that variable rates are the better choice much of the time, but locking into a fixed-rate mortgage at the right time can result in mortgage rate savings. We will address the variable rate lock in feature, later in this article. 

Some will point to higher interest rates during the 1980s and 1990s, and the current 2022 – 2023 rate increases as a reason to avoid a variable rate. This thinking is understandable, however, as we will review below, we live in a very different, debt-laden economy now whereby the effects of a 1%  higher Central Bank rate can have over 3 times the economic impact as a 1% higher rate did in the 1980s. Indeed, adjusted to inflation, private and public debt levels are currently more than 3 times higher than in the 1980s.

For example, a house in the 1970s and 1980s may cost $40,000 with a $30,000 mortgage.  Today, an average house in Canada costs well over $400,000 with many mortgages over $300,000. In the GVA and GTA, these numbers are more exaggerated. 

These are different economic times, with different consequences of higher rates.

Therefore, I contend that even with high inflation, we are not likely to see the kind of high 10%+ rates that were seen in the 1980s and 1990s, and that rates will ultimately gravitate downward over the medium-long term. The variable rate strategy may be seen like a ‘buy and hold’ stock market strategy. Over the long term, you are likely to do well, as long as the shorter term periods of volatility can be withstood.

Why the variable should stop increasing in 2024, and when its expected to drop

The main pre requisite for variable mortgage rates to drop is for inflation to fall to the 2% range. It’s projected by the Central Bank of Canada that the economy will run slowly enough by summer 2024, to allow inflation to drop low enough (to the 2% range) for rate cuts to begin.

Looking at this statement more closely, there are 2 competing forces in the economy now: 

1. On one side there is government stimulus and population growth providing upward growth pressure.
2. On the other side are high interest rates that are creating downward, restrictive economic pressure.

Given the interplay between these competing forces, we are seeing a mixed economic reality, but a reality that has led the Central Bank of Canada to indicate that rates are currently high enough.  

The main data showcasing the effects of high interest rates are:

GDP Per Capita: The size of Canadas economy in dollars, divided by the size of the population

Real GDP growth: This is Canadas economic growth rate, minus the rate of inflation. For example, if Economic Growth is 2%, and inflation is at 3%, then Real GDP is -1%. 

Both of these data points are very negative, indicating a major economic slowdown among the population, with many households feeling the pinch. (For more details on this see our Rate Forecasting Article)

On the other hand, considerable government spending and population increases are still leading to economic growth on the surface level. In other words, we have more people buying more total goods and services, but on an individual/’per person’ level, spending is dropping.

It is well known in economics that it takes up to 2 years for the effects of a rate increase from the Central Bank of Canada to have full impact on the economy. 

Given the first rate increase was in March 2022, we are just starting to see the full effects of the first 0.25% rate increase. So as we progress through 2024 we will continue to see the full effects of all 4.5% of rate increases.

Given this, the Central Bank of Canada believes rates are currently high enough to cut through the economic stimulus mentioned above, given enough time.

So the bigger questions now are,  WHEN do the rates drop? And, How low are variable rates likely to drop? 

There are two views on when variable mortgage rates are likely to drop: 

1. Financial Market Forecast
2. Central Bank of Canada Commentary

Financial Market Forecast: 

According to financial market consensus, when looking at the Government of Canada Bond Yields and other interest rate sensitive economic indicators, the Central Bank prime rate and therefore variable mortgage rates are likely to see their first drop in July, 2024. Below is a projection based on forward contracts of the Canadian dollar. For this projection data, we should pay closer attention to the July probabilities because there is a continuation from June, of a 70% likelihood rates will be at 4.75% in July. Bond markets also align better with a July cut. 

Source: WOWA, Mar 7 2024

Central Bank of Canada Commentary:

The financial markets are in line with the Central Bank commentary given at their most recent meeting in January, 2024. Although the Central Bank is not providing exact guidance on when they might cut rates, they are indicating that it will take until the summer months for inflation to firmly settle below the 3% threshold that they want to see, before they consider a rate cut.

So, overall in 2024, there is a probability that we will see 0.50% – 0.75% of rate cuts, and an equivilent drop in variable mortgage rates.  As long as inflation remains stable or decreases during these first rate cuts, we are likely to see another 1.25% worth of rate cuts in 2025/2026.

Together, 2% of rate cuts would bring the Central Bank of Canada to the high end of its ‘neutral rate range’ that is expected to neither stimulate economic growth, nor suppress economic growth. 

The high end of the neutral rate range is targeted as the post covid economy may be more sensitive to inflationary pressures. 

This would likely result in variable rates settling in the mid-high 3% range.

However, if disinflation continues, there is potential for rates to drop further into the neutral rate range.

How does the Central Bank prime rate differ from the variable mortgage rate?

It is important to note that the Commercial Bank (ie. RBC, CIBC, BMO etc…) prime lending rate is different from the Central Bank overnight lending rate. More specifically, the Commercial Bank prime lending rate is 2.2% higher than the Central Bank of Canada rate. This difference between the Central Bank and Commercial Bank rates is the ‘spread’ whereby the Commercial Banks make their profits, and this spread will typically remain consistent over the long term.

So what we see happen to the Central Bank rate, add 2.20% on to this. For example, at the current time of writing (March, 2024) the Commercial Bank rate is 7.20% (5% Central Bank rate + 2.20% spread).

Next, to arrive at your specific variable rate, the Commercial Banks and mortgage lenders will typically offer ‘prime minus’ discounting, such as prime minus 1%. So if you have a prime minus 1% mortgage, your mortgage rate would be 5.95% using this example.

For more information on interest rate forecasts and predictions in 2023 – 2024, click here to check out our article.

Variable-rate questions and considerations:

Pre covid, for a year starting October 2018 the economy was doing well, the Central Bank Rate was steady at 1.75% and the Commercial Bank Prime lending rate was 3.95% at its 10-year high point. What would your rate be given the ‘prime minus’ variable rate? A prime minus 1% discount is a good example.

There’s a reasonable possibility that rates return to 2018/2019 levels. But even if rates bottom out 1% higher than pre covid (perhaps in late 2025), at 2.75% and bank prime at 4.95%, this will still position most variable rate holders in the 3.75% – 3.95% range.

Fixed or Variable Mortgage: How to Minimize the Risk Associated with a Variable Mortgage

Here we revisit the fundamental question of why we are even taking the time to discuss a fixed or variable mortgage. The answer for most is to save more money on their mortgage, in one way or another. 

The strategy here will show you how to lower your risk on a variable mortgage while also setting you up to save substantially on interest over time.

I call this more specifically, ‘variable rate risk mitigation’ and it involves using the extra payment/ prepayment privileges found in the mortgage fine print terms to increase your variable mortgage payment to the same payment that you would be making at a higher rate 5 year fixed rate mortgage.

For example:

Then using prepayments, boost the variable payment by $282 per month to $1,626 – the same payment as you would have been making on the fixed rate.

Variable vs fixed rate mortgage: Pre Payment Result given higher variable rates in 2024?

Many will quickly point out that currently, as of  April 2024,  fixed rates are about 1% higher than variable rates.

To keep a long story short, fixed rates are currently lower because financial markets (mainly in the Bond markets) are already pricing in lower Central Bank of Canada Rates in 2024-2025.

Given this, the variable rate mitigation strategy needs to be seen in a different ‘inverted’ way in 2024 – 2025.

Today, variable rate payments are higher than fixed. But when the variable rate drops, the equivalent payment on a fixed rate should be maintained. More specifically, if in 2 years, the variable rate payment is now lower than what today’s 5 year fixed mortgage rate would be, then for the variable rate, the higher payment should be maintained. Given this example, there would be 3 years out of a 5 year term where you are paying down the 5 year variable rate mortgage faster than the 5 year fixed rate. It could be that in 2-3 years, rates are approximately 1% lower, which could mean significant savings.

The main point to be taken, for this strategy is to make extra payments on the variable rate, if/when the rate is lower than the comparable fixed rate.

Please note that the correct type of variable rate should be chosen to execute this strategy. Various mortgage products will behave differently once rates begin to fall. Connect with Altrua Financial today to determine your best and lowest variable or fixed rate mortgage product.

Variable mortgage vs fixed: How variable offers more flexibility and lower penalties than fixed 

Closely related to lowering risk, as emphasized in the last point, the lower penalties and increased flexibility built into a variable rate mortgage are a cornerstone of a variable rate.

In fact, some mortgage and financial professionals go as far as to say the lower variable rate penalty is the main benefit of a variable rate mortgage, given how fixed-rate breakage penalties can easily reach into the $10,000 + range. 

When looking at a variable vs fixed mortgage, it should be taken into account that, especially during the first 3 years of a 5 year fixed rate mortgage, the penalty to break the mortgage can be extremely high.

As a mortgage broker for over 15 years, I have seen many individuals faced with massive ‘interest rate differential penalties’, when breaking their mortgage for any number of reasons:

• Moving
• Refinancing to pull out equity
• Switching into a lower rate
• Family changes
• Many more…

This trend was especially the case in 2021 as many who are in a fixed-rate mortgage in the 3% range were faced with cost-prohibitive penalties in the $10,000’s to break their higher-rate mortgage. This was not the case for those in a variable rate mortgage, and this kind of variable rate flexibility could certainly come into play again in 2023-2024 as fixed rates may decrease notably.

While a detailed discussion of penalty details is beyond the scope of this article, the point is that most variable rate mortgages (the mortgage products without high penalty fine print) will only ever charge 3 months interest penalty if you end up breaking the mortgage. The 3 month interest penalty is far lower – often to the tune of thousands of dollars lower than comparable fixed rate mortgage penalties.

Five years, the standard fixed-rate mortgage term, is a long time, and it can be difficult to tell exactly how economics and financial markets will play out years into the future. So an important financial planning strategy is to remain flexible and agile to help accommodate changes. 

The variable rate mortgage is, in many cases, the right financial tool to help accommodate these changes. But is it the only way to help increase flexibility and lower penalty risk?

We will take a close look at this question just below. But first…

Timing a Fixed Rate Lock-In?

**Click here for a special variable rate lock in feature article**

 One of the fundamental benefits of a variable rate is the ability to lock into a fixed rate.

If you want to lock into, for example, a 5 year fixed rate now, the best market rates are in the 4.75% – 5.25% range. With a lock in, you would not have to worry about potential further increases down the road, but you will have limited your downside rate drop potential that may happen later in 2024/2025.

But if you’re leaning towards a fixed rate lock in, in 2024, instead of a 5 year fixed rate, it could make more sense to lock into a shorter term fixed rate such as a 3 year fixed rate. Why?

Because the effects of these high rates are slowing the economy and inflation. This should continue to produce lower fixed mortgage rates.

With a shorter term fixed, you could buy some rate stability as we approach peak Central Bank rates, while also leaving open the opportunity to renew into a lower market rate on the maturity date (renewal date) of the shorter term. It’s a strategy to reduce risk, provide some better stability and leave open some potential to have a lower rate sooner.

Visit our article here for a more thorough discussion of locking in a variable rate.

2024 Variable Rate Analysis Conclusion

While it’s projected by financial markets and economists that within 2 years, the variable rate is likely to be approximately 1% lower than current fixed rates, there is no guarantee.

For those with a strong belief in the efficiency of markets and historical patterns of the variable rate,  there could very well be considerable savings over the next 5-10 years in variable as we enter a new economic cycle. But realizing these longer term savings will take a higher risk profile in 2024 as we have yet to see the imminent proof of when the variable rate will start dropping. Once the variable rate starts dropping, there could be a rush into this rate type, and perhaps less discounting off of prime.

Why a fixed rate mortgage will be the best path for many.

As we move into 2024, we saw fixed rates start to drop given an expected rate cut in the first half of 2024. However its looking like it will take until the second half to see a rate cut so fixed mortgage rates are likely to fluctuate in the first half of the year.

As the inflation fins its way lower, fixed rates will continue to decline, ahead of Central Bank rate (i.e. variable rate) decreases, and could be substantially (ie. 1%+ lower in 2-3 years). Given the potential for even lower rates, it can make sense to take a shorter term fixed rate, such as a 3 year fixed rate, instead of a 5 year fixed rate. This is because you would renew sooner (ie. 2 years sooner) at a lower rate, while also protecting yourself from higher variable rates in 2024.

Why fixed rates more specifically?

Stability and Peace of Mind:

How does one measure peace of mind? It’s nearly impossible to measure, and its value can be near infinite. What’s the point of saving $5000 on your mortgage if you’re going to lose sleep for the next 1-2 years? It’s not worth it in this case. 

Along with peace of mind, the fixed rate mortgage will provide better stability and consistency in payments during this inflationary time of more ‘what ifs’. If inflation remains resilient and these already high rates don’t lower it, rates could go higher than currently projected, although not likely too much higher. A short term fixed rate would provide more stability and consistency for this period.

Top benefits of a 3-year fixed rate.

• Rate protection for the next 3 years.
• Can be a significantly lower rate than a variable rate currently, and for months ahead.
• Better opportunity to renew into a lower rate if the economy slows down and rates fall within 3 years.
• Ability to renew into another short fixed term, such as a 1-year or 2-year term if rates have not entirely dropped by the end of your term.

The benefits of a 5-year fixed rate.

• Currently lower rates than 2-3 year fixed rates.
• More protection and peace of mind as we are in a unique and less certain point in history.
• Less management or thinking about the mortgage in general.

Some questions and personal considerations to determine your best fixed or variable rate strategy.

• Do you have a good understanding of how the variable rate works, and how swings in the rate can affect your mortgage payment?
• If you were to buy an investment, such as a mutual fund, would it be:
  • Conservative? (low risk, lower return). Consider a 5 year fixed mortgage rate.
  • Balanced? (moderate risk, more volatile, but more opportunity for higher returns). Consider a 2-3 year fixed rate.
  • Aggressive growth? (more risk, more volatile price fluctuations, the maximum opportunity for a higher return. Consider a 1-2 year fixed rate.
  • If you’re unsure of what investment category you’d fit into, try googling an investment risk profile to see where you might end up.
• Are you comfortable if the variable rate increased slightly higher, and could potentially increase further than projected?
• Beyond theory, if you see and feel rates increasing, will your feelings be the same? Or are you more likely to stand by your initial strategy if emotions run higher?
• Do you have some excess or can you create excess cash flow to manage higher variable rate payments? Or would potentially higher variable rates put you in an extremely uncomfortable or dangerous financial position?
• Have you calculated what your maximum tolerable mortgage payment can be? What kind of variable rate would this look like? Are you comfortable with this rate?

When working alongside an experienced mortgage professional, your answers to these questions and others will help you arrive at your best answer.

The decision can be made decisively, but if you have not arrived at your best answer immediately, sleep on it for a few days until your decision becomes most apparent. If differing views between spousal partners, consider splitting or balancing the risk and strategy.

Thank you for reading, and connect with us at Altrua for answers to your questions and a customized approach to deciding on rate.