Your Mortgage Is a Risk Decision, Not Just a Payment Decision

When Canadians shop for a mortgage, one number often gets all the attention: the monthly payment.

A variable-rate mortgage will frequently offer a lower payment than a fixed-rate alternative. At first glance, that seems like an easy decision. Why pay more if you don't have to?

The problem is that a mortgage is not just a financing decision. It's a risk management decision.

Many Canadians learned this lesson the hard way during the recent interest rate cycle. In March 2020, the Bank of Canada cut its overnight rate to just 0.25%. By July 2023, that same rate had climbed to 5.00%. Variable-rate borrowers who selected the lowest payment available suddenly found themselves facing dramatically higher interest costs.

What is often overlooked is that a lower payment does not necessarily mean you are paying down your mortgage more efficiently. With many variable-rate mortgages, a larger portion of the payment can go toward interest as rates rise, while less goes toward principal. In some cases, borrowers can find themselves covering mostly interest while making only limited progress reducing the balance owed.

The latest mortgage renewal survey from Royal LePage highlights the lingering effects of this period. More than one-third of mortgage holders expect higher payments at renewal, and over three-quarters of those expecting increases believe those higher costs will create pressure on their household finances. Many plan to reduce discretionary spending, postpone travel, or delay home renovations as a result.

Interestingly, Canadians are increasingly embracing variable-rate mortgages. Housing analyst Ben Rabidoux recently noted that five-year fixed-rate mortgages now account for only about 20% of mortgage debt outstanding, while variable-rate borrowing has reached a record high.

Source: Ben Rabidoux

Why the shift?

Part of the answer is affordability. Higher home prices and larger mortgage balances make every dollar of monthly payment matter. But affordability today does not eliminate risk tomorrow.

Before choosing a variable mortgage simply because the payment is lower, consider a few questions:

• Could your budget handle rates two or three percent higher than today?
• Would higher payments force changes to your lifestyle or spending habits?
• How would you feel if rates moved in the opposite direction of market expectations?
• Is payment certainty worth paying a little more for?

There is no universally correct answer. Variable-rate mortgages can work well for some borrowers. However, history reminds us that interest rates can change far more quickly than most people expect.

The goal shouldn't be to find the cheapest mortgage payment available today. The goal is to find a mortgage that's still manageable if the future doesn't unfold as planned.

After all, financial plans rarely fail because of what we know. They fail because of the risks we choose to ignore.

 

Fraser Betkowski

 

The opinions expressed in this report are the opinions of the author and readers should not assume they reflect the opinions or recommendations of Richardson Wealth Limited or its affiliates. Richardson Wealth Limited is a subsidiary of iA Financial Corporation Inc. and is not affiliated with James Richardson & Sons, Limited. Richardson Wealth is a trade-mark of James Richardson & Sons, Limited and Richardson Wealth Limited is a licensed user of the mark. Richardson Wealth Limited, Member Canadian Investor Protection Fund.