Plenty of us have not experienced an era where borrowing rates were above 6%. For most, debt has been relatively accessible and inexpensive. We tend to forget that since 2008, policymakers have set borrowing rates artificially low to avoid a financial collapse and incentivize the economy. Why these rates stayed low for an extended period is another topic. But given the recent rapid increases in overnight lending rates, we now find ourselves asking whether to go with a fixed or variable rate mortgage.
Fixed rates offer peace of mind because when you agree to a rate, the mortgage contract guarantees the rate for the duration of the term. The monthly mortgage payments will be set throughout the period and will not change until maturity. This is akin to the saying “set and forget”. Fixed rates are ideal for longer periods of stabilized cash flow and assets.
Variable rates, on the other hand, have the potential to benefit from decreasing rates. Conversely, an escalation in lending rates will result in a corresponding rise in interest rates. Typically, lenders provide prepayment flexibility with variable rates, making this option ideal for shorter-term debt where changes in interest rates are less likely to significantly impact the overall cost over the duration. Furthermore, lenders are more likely to offer amortization flexibility, including options for interest-only payments, which can lower monthly mortgage payments and place less strain on cash flow.
To understand where lending rates have been and as a general benchmark, below is a graph that tracks the Bank of Canada’s Overnight Lending Rate and corresponding Canadian Prime Rate for a period of just over 20 years.
Graph created by Nicola Wealth Mortgage Investments team, using data from WOWA
Notwithstanding the rapid increase in lending rates in the last 12 months, we have experienced prolonged and unprecedented record-low rates since 2009, with Canadian Prime Rates averaging 3.0%. As mentioned, dips in rates generally coincide with the government's decision to stimulate the economy following economic turmoil, such as the Dot-com crash in the early 2000s, the Global Financial Crisis in 2007-2008, and the COVID-19 pandemic in 2020. More recently, the outcome of the pandemic has led to alarming levels of inflation, prompting governments and the Bank of Canada to take decisive action. Early indications suggest that inflation in Canada has started to slow down, but not enough for policymakers to pause, as evidenced by the most recent increase in the Bank of Canada's Overnight Rate. Whether this represents the peak of lending rates or a 'new normal' remains uncertain. It's worth noting that lending rates did reach double digits in the 80s and 90s.
Should mortgage rates be fixed or variable?
Considering the current rate environment, many borrowers have opted for fixed rate mortgages to secure their borrowing costs and protect against potential rate hikes. Others prefer the flexibility of variable rates, especially for short-term debt, as they offer the possibility of lower monthly payments and the potential to benefit from falling rates. When deciding between fixed and variable rates, it's essential to assess priorities, including payment stability, flexibility, and the ability to absorb future rate increases.
As investors in the Nicola Mortgage Investment Funds, you may benefit from a well-rounded investment strategy that provides access to a diversified mix of income-producing commercial and residential mortgages. The funds are carefully curated to maximize risk-adjusted returns, undergo rigorous underwriting and due diligence processes, and are continuously monitored to align with the mortgage funds’ mandate. With the expertise and experience of our investment team, we navigate these uncertain times, offering prudent risk management while working to achieve strong returns.
This material contains the current opinions of the author and such opinions are subject to change without notice. This material is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information presented here has been obtained from sources believed to be reliable, but not guaranteed. All investments contain risk and may lose value. Please speak to your Nicola Wealth advisor for advice based on your unique circumstances. This is not a sales solicitation. This investment is intended for tax residents of Canada who are accredited investors. Please read the relevant documentation for additional details and important disclosure information, including terms of redemption and limited liquidity. Nicola Wealth Management Ltd. (Nicola Wealth) is registered as a Portfolio Manager, Exempt Market Dealer and Investment Fund Manager with the required securities commissions.
