How to decide if you should lock in your fixed-rate mortgage or stay

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Historically, variable rate mortgage holders have saved more money than those who chose a fixed rate mortgage. This is because they have been able to benefit from long periods of low interest rates. While that may be true, there are many homeowners who currently have an adjustable rate mortgage who have felt the squeeze when the Bank of Canada (BoC) hiked interest rates. And it probably won’t wear off anytime soon.

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The BoC is likely to hike rates again on Oct. 26, with some analysts saying they could rise another 50 basis points. That would be the sixth hike since March for a total increase of 350 basis points, or 3.5 percent. From a homeowner’s perspective, this will increase the monthly payment even further. If you are short on cash, you can of course consider a fixed-rate mortgage. But before you take the plunge, it’s good to know all of your options.

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How rising interest rates affect your monthly payments

First of all, there are two types of adjustable rate mortgages: fixed rate mortgages and adjustable rate mortgages.

With a fixed rate mortgage with an adjustable rate, your monthly payments stay the same each month. As interest rates rise and fall, the amount of your payment used for interest changes.

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When interest rates rise, more of your payment goes into interest rather than your principal. This lengthens your amortization schedule, ie the amount of time it takes to amortize your property. Eventually you will reach your trigger rate, where your interest payments will exceed your total payments. When that happens, your lender will require you to adjust your payment amount so you can rebuild equity.

Adjustable rate mortgages (ARM) increase or decrease the amount you pay each month based on your lender’s prime rate. For example, if your ARM is Prime -1 and your bank’s prime rate is three percent, your mortgage payment would be calculated at one percent.

Now let’s look at how rising interest rates would affect a homeowner with a $500,000 ARM and a 25-year payback schedule. We assume that you will receive monthly payments:

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In this scenario, if the homeowner started their ARM at 2 percent and is now at 5 percent, their payments would have increased by nearly $800. Another one percent increase and the difference would be more than $1,000.

Every mortgage is different. Each lender sets its own prime rate and offers homeowners different discounts when taking out an adjustable rate mortgage. The example above shows how rising interest rates would have affected your mortgage if interest rates continued to rise.

Here’s how to decide if it’s time to lock yourself up

Although every situation is different, many people have chosen an adjustable rate mortgage because they believed it would save them money. The idea is that they could endure changes during the life of their mortgage.

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However, in the current interest rate environment, those who have opted for a floating rate are now paying more than the fixed rate originally offered. Nobody likes to be on the losing side of a bet, so you need to consider your individual situation to decide what’s best for you.

If your monthly payments keep you from sleeping every night, it is best to switch to a fixed-rate mortgage before the interest rate announcement. This allows you to secure an interest rate for the next five years. With rates expected to rise in a few days, it would probably only take one more rate hike for you to break even or stay ahead.

Most lenders will happily convert your adjustable-rate mortgage to a fixed-rate mortgage with no additional fees because you commit to them.

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You shouldn’t feel “lost” by switching to a fixed rate. Think about it like this. You originally thought you could handle the volatility of a variable interest rate, but you’ve learned it’s not for you. If you lock yourself in now, you can rest easy.

On the other hand, if you currently have an adjustable rate mortgage and only have a year or two left. It might make sense to sit things out. That’s because you would have been on the right side of interest rates for a number of years. If you switch to landline now, you will be locked in at a higher rate. Since you’ll need to innovate anyway, you can also see where things are going.

One thing to note. If you decide to switch to a fixed rate mortgage and later have to cancel your mortgage, the fees are usually higher than with an adjustable rate mortgage. In other words, it might be beneficial to stay on a variable if you need to cancel your mortgage before the term is up.

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What other options do you have?

Converting to a fixed-rate mortgage with your current lender or getting rid of variable rates are just two options you have. There are two other paths you could take, but they’re not necessarily better.

One option is to cancel your adjustable rate mortgage agreement, pay the penalty, and then get a new adjustable rate mortgage. This would only be better if the new adjustable rate mortgage offers a bigger discount than you’re already getting.

The other option is to foreclose your mortgage, pay the penalty, and get a new fixed-rate mortgage with another lender. This could work to your advantage if other lenders offer better fixed-rate mortgages compared to your current lender. Of course, you have to consider the penalty you would have to pay to see if the overall savings are worth it.

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Get advice from a professional

While interest rates are expected to rise shortly, no one knows what the future holds. If you’re worried about future payments and your budget, it’s probably worth securing now. The benefits of knowing exactly what your monthly payments will be for the next five years on a fixed-rate mortgage can trump any savings you can make with an adjustable-rate mortgage.

However, it is always in your best interest to speak to a mortgage specialist or broker as they can help you understand your options and find an ideal solution for your situation.

This article is informational only and should not be construed as advice. It is provided without any guarantee.