With borrowing costs more likely to fall than rise—and by a lot in a possible trade war—a floating rate mortgage could pay off.
Lower interest rates have awakened Canada’s housing and mortgage markets. Annual growth in residential mortgages has reached 4% for the first time since mid-2023 (Chart 1). Sensing the central bank may reduce rates further, more borrowers are opting for a floating rate loan. But is that the right choice?
If the rate outlook unfolds as we expect, it could well be. Although variable mortgage rates currently stand a little above five-year fixed rates, they are unlikely to stay there. Assuming the Bank of Canada reduces policy rates by 25 bps in April and again in July to 2.5% (and variable rates follow suit), a floating rate could pay off handsomely. We estimate a borrower putting 10% down on a half-million-dollar home financed over 25 years would save an average of 40 bps per year compared with locking in for five years. That equates to just over $100 per month or more than $6000 in five years.
An added benefit of choosing variable is that, in the event a trade war torpedoes the economy, the Bank could reduce rates aggressively, possibly by an additional 100 bps to 1.5% (Chart 2). And, assuming that rates stay low for a full year, variable-rate borrowers would save an additional 29 bps on average in five years, or an extra $74 per month. They would not only benefit from potentially much lower rates, but also have the option to lock in should rates rise unexpectedly.
Our forecast for the policy rate aligns with the market’s view of 50 bps in rate cuts this year. Still, there’s no guarantee the Bank will lower rates further. Recent comments suggest a more patient approach after chopping rates by 200 bps to the upper end of a neutral range. The Bank was also vague on its Plan B for tariffs, given the uncertain inflation response, though we suspect a rising jobless rate would throw caution to the wind. Should the Bank stand pat on rates, locking in could pay off moderately. Furthermore, the economy could strengthen materially if a trade war is averted, causing inflation to reheat and the Bank to unwind some rate cuts. In this case, a fixed rate would clearly be the better choice. Even if policy rates fell moderately further, locking in at rates that already reflect future policy easing might be worth the cost of insuring against the risk of higher interest rates. In fact, after falling 1½ ppts since November 2023 to around a two-decade mean, five-year fixed rates have largely normalized.
A third option worth considering is a fixed rate of less than five years. This provides an opportunity to refinance at a possibly much lower rate in a few years. For example, the three-year mortgage rate is currently modestly below the five-year rate, and could be renewed at a lower variable rate in three years based on our outlook for policy rates, saving an average of 20 bps annually over five years relative to the current five-year rate. While that’s still 20 bps higher than opting for a variable rate today, the extra cost may be worth paying to hedge against potential rate increases.
Bottom Line: In our view, interest rates are more likely to fall than rise—and possibly by a lot—suggesting that a variable rate mortgage could be an attractive option when refinancing or buying a home. Still, this is an intensely uncertain period and borrowers have different needs based on their financial position and risk tolerance, so it’s likely best to speak to a mortgage advisor to weigh all the options.