May 2021 Mortgage Rate Outlook
Financial markets haven't been this worried about inflation in years. And the Bank of Canada is starting to see the writing on the wall. Inflation risk is growing. That's compelled our central bank to move forward its estimate of the first rate hike to the last half of 2022. This tilts the odds slightly in favour of longer-term fixed rates.
The predictions that follow are based on Bank of Canada forecasts and implied (future or forward) rates in the bond market. Take them all with a grain of salt because a lot can change in a matter of months.
- Bank of Canada forecast:
- The first BoC rate increase is still slated for the second half of 2022
- Source: Bank of Canada
- Consensus economist forecast:
- No overnight rate (and prime rate) hikes until the fourth quarter of 2022
- Bond yields to increase modestly through year-end
- Source: Bloomberg, economist forecasts
- 5-year fixed rate in five years:
- 3.25%, which represents today's best nationally available uninsured 5-year fixed rate plus the projected increase in Canada's 5-year yield by 2026
- Source: RATESDOTCA, Bloomberg forward rates
- Estimated long-term "neutral" rate:
- 2.25%, according to the Bank of Canada (i.e., two points higher than today)
- That's an average of where the overnight rate is projected to land long term.
- That implies a 4.45% prime rate
- Source: Bank of Canada
The 5-year fixed (insured, insurable or uninsured)
- Reason: Five-year fixed rates are the best insurance you can get against unexpectedly high inflation. And if the BoC does not hike as much or as fast as expected, you won't get too burned on interest costs.
- Beware: Fixed rates have notoriously high prepayment charges, particularly if you use a top-10 bank. A RATESDOTCA poll found that 47% of 5-year fixed-rate borrowers renegotiated or refinanced before maturity. The best strategy for most folks who need five-year financing is this:
- avoid lenders with punitive prepayment penalties, and
- lock into a 5-year term to manage risk.
The 3-year variable (insured)
- Reason: With a record-low 0.95% effective rate, you almost can't say no. Yes, rates are going to rise as soon as 2022. But you're going to save significant interest before that happens. A 3-year also lets you renegotiate earlier (than a 5-year term) at any lender and without penalty. You can even lock into a discounted 5-year fixed if you absolutely must. (Albeit, we're not huge fans of converting into a fixed rate before maturity.) Unfortunately this offer is good for default-insured mortgages only. If you need an uninsured variable, expect to pay 1.25% or more.
- Beware: Like we said above, inflation risk is no joke. Prepare for multiple rate hikes before this mortgage matures. Maybe you'll get lucky and won't see them, but most likely, this coming rate-hike cycle will have a higher peak than past cycles thanks partly to all the stimulus and supply shortages we're witnessing.
The 5-year hybrid (insured, insurable or uninsured)
- Reason: Rate predictions are usually a shot in the dark, so why bother? This mortgage hedges your bets. It's half fixed and half variable, so you can never be too wrong. It can also be coupled with a handy readvanceable line of credit (LOC), assuming you have 20% equity or more.
- Beware: The price for this best-of-both-worlds option is slightly higher refinance costs in five years—a small price to pay for the flexibility it affords, especially if you opt for the readvanceable LOC.
Glossary: Insured: A mortgage that has customer-paid default insurance (typically purchases with less than a 20% down payment); Insurable: A mortgage that has lender-paid default insurance and 20% equity or more; Uninsured: A mortgage without default insurance (this includes all refinances, all amortizations over 25 years, purchases of properties over $1 million, non-owner-occupied rental properties and other mortgages not meeting default-insurance rules).
Reader note: The generalized guidance above doesn't apply to all because everyone's circumstances are different. It's a good idea to consult a mortgage professional for advice focused on your personal finances, goals and five-year plan.