Depending on when you read this post, my decision to go with fixed might or might not be the popular choice (popular in Summer 2023, unpopular in Early 2022). As of the writing of this post, Bank of Canada’s (BOC) target overnight rate is at 5%. Some think this is the peak, but others think there are more rate hikes to come. The next rate announcement is 7 weeks away on Sep 6. It is hard to believe that it was only 15 months ago when the overnight rate was only 0.25%.
If you have been following the news or know people who went with variable back then, you are probably no stranger to payment increases whenever BOC announced a rate hike (every lender has different policy on what happens when rate goes up so mileage varies to an extent). Personally, the mortgage for my principal residence was locked into a 5-year fixed rate from before COVID so I haven’t been directly affected. However, it was only a matter of time. Like many who got a mortgage before COVID, my renewal time has come.
As the title suggests, despite the high interest rate (but then it’s all relative), I went with fixed rate again. I went through the process 4 months before my renewal because you can lock into a rate as early as 120 days before your renewal date. If the rate went down in the months leading up to my actual renewal date, I was reassured by my mortgage broker that I can still take advantage of it as long as I qualify. Since there was nothing I can do about where the rate was at or where it was heading, I decided to do what I can which was to contact my bank and mortgage broker as early as possible. I will write another post on how I shop for mortgage rates separately.
In this post, I want to share the reasons why I went with 4-year fixed rate for our principal residence this time (Summer 2023). Note, my reasons are strictly applicable to my situation. I don’t believe in one size fits all when it comes to personal finance so I am not sharing with the intent to convince you on one over the other. I am sharing with the intent to show you what my thought process was because I believe we should be in full control of our personal finance.
I Budget & Fixed Rate Mortgage Offers Predictability That Helps Me Sleep At Night
The reason why I say there is no one shoe fits all when it comes to personal finance is because financial decisions should be made based on the following factors (in no particular order):
- risk tolerance
- financial situation
- goals and plans
When we got our very first mortgage, the big bank’s adviser told us that variable rate mortgages have historically been cheaper in the long run. I actually forgot about the fact that he made a comment at all until Eric reminded me years later. I likely subconsciously forgot about it because I knew we were going fixed before I went to the appointment. We were renters for years before that and we have enjoyed the predictability when it came to renting. One of the criteria when we shopped for our first place was that the total housing costs had to be roughly what we would pay if we continued to rent. It was our first home purchase and I wanted the same predictability over all else. On top of that, there was simply no guarantee I would come out ahead with certainty if I had gone with variable.
Fast forward 6 years, our income has more than tripled and our net worth has grown significantly. However, I still went with fixed partially because of my answer to a question Eric asked me:
“Will you lose sleep if the rate continues to increase or stays that way for a while?”
Yes, I will. Not knowing how much I need to set aside for the roof over my head every time there is a rate announcement would stress me out. I have been budgeting for years and I like having control over where I will be financially in the future to an extent. My system has worked for me as it allowed me to travel or make big purchases with just a bit of planning and very little stress.
While I might save money (potentially thousands) by going variable, it simply isn’t worth the volatility to me right now.
The Mortgage for Our Principal Residence Is Our Biggest Debt
This ties nicely with my previous point about budgeting. Because fixed rate mortgage offers predictability that variable rate does not, any change to the mortgage for my principal residence has a much bigger impact than my other much smaller debt like our car loan.
For an average mortgage size of $364,000*, a 0.25% rate hike equals to $50 more in monthly payment. While this might not be a mind-blowing amount, the money has to come from something else. Unless you can just ask your employer for a $1.7K raise (equals to $50 take-home if you made $75K in BC) on the spot, otherwise the shortfall needs to be funded by money that would have gone to your savings or an expense more fun than mortgage. Since BOC raised the interest rate from 0.25% to 5% in 15 months, the monthly payment for a $364,000 mortgage would have increased $865 per month representing a staggering 70% increase.
So, while I understand the arguments that support variable mortgages (e.g., the much lower penalty to break the mortgage), I decided not to take the risk on our biggest fixed expense.
I Don’t Believe Bank of Canada’s Target Overnight Rate Will Go Back to 0.25% Anytime Soon
In fact, I really hope it does not because of what happened that brought us there. There were only two times our overnight rate went as low as 0.25%: during the 2008 – 2009 financial crisis and the pandemic. I was barely in the workforce and definitely did not have a mortgage back in 2008. But I lived through the pandemic and while there was not a lot to complain for myself, there were a lot of people who were affected negatively in a major way. It is not something worth repeating for the sake of all-time low mortgage rates.
Hopes and feelings aside, I simply don’t think BOC will make any drastic and major move unless something of the same scale as the 2008 financial crisis or pandemic takes place. Statistically-speaking, it should not be happening again soon. But who knows?
So, the potential of me missing out on some drastic rate decreases because I chose to lock into a fixed rate now is something I am comfortable with.
I Am Not Saying No to Variable Mortgage As A Blanket Statement
In fact, my decision with this mortgage has a lot to do with my overall financial situation. While our principal residence is our biggest mortgage, we have other mortgages coming up for renewal/closing in the next 12 months. Depending on how the economy looks, I might or might not consider variable rate for the first time. Unlike my principal residence, everything else is an investment. I can always sell (even at a loss) if I want to liquidate or be freed from the financial obligations for any reason. As long as I am not out of a place to live, I know I will be fine with offloading anything else.
This also affected the mortgage term I chose. Based on what I read and from what I was told, many chose to go with a shorter term (e.g., 3 years) instead of the once-popular 5-year as rates are “high” right now. While people chose to go with fixed now, their hope is to be able to go back to the rate shopping game again sooner rather than later assuming the rate will go back down once inflation is in control.
Instead of the more expensive 3-year term or cheaper 5-year term, I ended up choosing the 4-year term because my intention was to spread my renewal dates. I prefer to have one mortgage renewal per year rather than them all happening at the same time. This way, I can apply the dollar-cost-averaging concept albeit at a larger scale than my usual stock purchase. For example, if I renew:
- a $400,000 mortgage in Year 1 at 4.5%
- a $275,000 mortgage in Year 2 at 5.5%
- a $200,000 mortgage in Year 3 at 4.0%
My weighted average mortgage rate is 4.7% instead of 5.5% (worst-case if I renewed all in Year 1) or 4% (best-case if I renewed all in Year 3).
At the end of the day, whoever tells you they can predict the future is not being honest with you. As a result, while I think it is important to keep an open mind when it comes to financial advices, you should be in the driver’s seat for all your financial decisions. Regardless of what happens, I know I did my best when I made the decision I did after analyzing my personality, situation, goals and preferences.