Fixed Rates Climb and Variable Rate Discounts Shrink: What Lenders Aren’t Telling You

Canada’s mortgage landscape has seen notable changes in recent weeks. Fixed rates hit multi-year lows in April, but have since reversed course and begun creeping upwards by 10-20 basis points, while major banks have simultaneously reduced their variable rate discounts by 10-15 basis points off prime.

For Canadians looking to enter the housing market or renew an existing mortgage, these simultaneous changes create a complex situation with no simple answers.

Fixed Mortgage Rate Alert: The Sub -4% Window Is Closing

Fixed mortgage rates that had reached their most affordable levels in nearly three years are now on an upward trajectory. In early April, five-year fixed rates dropped to the 3.64% – 3.7% range for insured mortgages, however, these rates have climbed within weeks by 0.1 to 0.2%, potentially increasing further.

The movement is even more pronounced in the conventional mortgage space, where the most competitive five-year fixed rates have crossed above the psychologically significant 4% threshold.

The primary driver behind rising fixed mortgage rates is the Canada five-year bond yield rise from a low of 2.46% on April 4 to 2.8% range in May (2.82% as of May 6). This significant jump in a short timeframe has directly translated to higher mortgage costs. Canadian lenders, who use these bonds to fund and hedge their mortgage portfolios, have responded by pulling back on the discounts they offered earlier in the month.

Variable Rate Changes: It’s All About the Discounts

On the surface, variable mortgage rates look unchanged as the Bank of Canada prime rate remains at 4.95% in the latest change on April 16. But below the surface, lenders have quietly reduced the discounts off prime they extend to borrowers, making variable mortgages less attractive.

In recent weeks, CIBC, Scotiabank, and some other banks have trimmed variable rate discounts by 0.1 to 0.15%. These shrinking discounts are a strategic move by lenders to incentivize fixed-rate borrowing because of economic uncertainty. Banks tighten variable rate lending when they fear impending rate hikes that would erode their profit margins on discounted variable products.

Historical Context of Variable Rate Discounts

The current tightening of variable rate discounts isn’t unprecedented. During the 2008 financial crisis, discounts all but disappeared, with some lenders offering variable rates at prime plus 10 basis points, a stark contrast to the prime minus 100 basis points (or better) that had been common before the crisis.

Today’s situation isn’t nearly as extreme, but it does reflect a similar pattern of lenders becoming more conservative during periods of economic uncertainty. While several lenders are still offering close to 100 basis points off prime on high-ratio mortgages through discretionary pricing, the trend of shrinking discounts appears likely to continue if market volatility persists.

What’s Ahead: Potential Mortgage Rate Scenarios

Given that economic forces impact variable and fixed rates differently, forecasting where rates will go next requires analyzing potential economic scenarios and Bank of Canada decisions.

Economists expected at least two more interest rate cuts from the BoC this year due to growing recession risk. Variable rates now exceed fixed rates, so choosing variable rates now means accepting a higher initial rate, hoping for future declines. After two cuts, variable rates would roughly equal current fixed pricing. Over a 5-year term, variables likely prove cheaper than today’s fixed rates. However, with rates near historical averages, potential savings may not compel some borrowers like past cycles.

The Bank of Canada may leave the prime rate unchanged if inflation stays persistently high. This would stabilize variable rates, but fixed rates would also level off without further declines in bond yields.

Our Advice on Your Mortgage Strategy

Given the shifting dynamics, what should Canadian borrowers do? Here are the key principles to guide mortgage decision-making right now:

• Lock in fixed rates below 4% while still available, for maximum stability
• Consider 3-year fixed terms to balance rate stability with flexibility
• Calculate variable rate savings based on potential further prime cuts
• Build in rate holds and pre-approvals to lock in rates
• Maintain extra payments capability to pay the mortgage down faster if rates rise
• Focus on flexibility: converting between fixed and variable, penalty-free

What if rates keep falling after you lock in? Don’t worry, the fixed rate fluctuation can be anticipated as it tracks the Government of Canada bond yields. In addition, up to 5 days before closing, lenders must offer lower rates if they reduce pricing.

If you are comfortable with fluctuation, variables offer potential savings long-term. However, they are best as a strategy, not for market timing, to convert to a lower fixed rate later. Conversion rates tend to be higher than initial offerings.

Remember, Not One-Size-Fits-All!

There is no universal advice. Staying informed about market conditions and making evidence-based mortgage choices gives borrowers the greatest chance of optimizing affordability, savings, and flexibility. Opportunities are always available, even when rates are volatile.

Discuss needs with an advisor to make an optimal decision. Weigh rate predictions, but focus on your timeline, budget and goals. Both options have merits today, so choose what fits your situation best.

FAQs

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1. Fixed rates are creeping up—and variable-rate discounts are shrinking too