Interest rates have gone up a great deal. We all know that. Where they go from here, we don’t know, but I certainly have a point of view. But the tough question to face is what to do with your mortgage, especially if it is now coming up for renewal?

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If I was in this position, I would either look for the best rate on a five-year variable-rate mortgage or switch to a home equity line of credit (HELOC) at prime or close to it, and look to either lock in a longer term at some point in 2024 or 2025 or move to a five-year variable rate.

To start the decision-making process, let’s look at what the current rates are. While these aren’t necessarily the best rates, here are some decent rates for those with an uninsured mortgage (mostly applies to those who don’t pay Canada Mortgage and Housing Corp. insurance fees).

1-year fixed: 7.1 per cent

2-year fixed: 6.7 per cent

3-year fixed: 6.3 per cent

4-year fixed: 6.1 per cent

5-year fixed: 5.9 per cent

5-year variable: 6.9 per cent (prime minus 0.3)

Home equity line of credit: 7.2% (prime)

Fixed vs. variable

Over the years, variable-rate mortgages have generally provided a better return than fixed-rate mortgages. One study by Moshe Milevsky, a professor of finance at York University in Toronto, found that Canadian homeowners would have been better off with a variable mortgage almost 90 per cent of the time between 1950 and 2000.

Since 2000, it has also been clear that variable-rate mortgages have resulted in lower interest costs for many. This makes sense since you are paying a premium for knowing exactly what your rate will be for a period of time — peace of mind.

In the minority of times that a fixed-rate mortgage has been better, it’s been during a period prior to rising rates. As we know, a fixed-rate mortgage that was locked in around 2020 at two per cent for five years is a pretty great place to be in today’s world. On the flip side, in a period prior to falling rates, a variable-rate mortgage is likely going to be the best option.

Just like any financial choice, part of the decision is based on your personality and risk appetite. If you know you want certainty and do not want to take risks, then a five-year fixed rate mortgage is very likely the best option for you regardless of where we are at in an interest rate cycle.  It may not prove to be the best financial decision, but the ability to budget around a set payment for five years can be worth a great deal for someone’s overall comfort.

My view is that the financial research shows that variable-rate mortgages are usually a better financial decision, and I believe we are in a period prior to falling rates. The Big 6 banks agree. Their year-end 2024 target for the bank rate is 0.75 to 1.5 percentage points lower than it is today. I believe the Bank of Canada will likely be lowering rates meaningfully during 2024. Based on this, I would suggest those with some willingness to take risks look at a variable-rate option today.

5-year term or shorter

Based on the bond market and yield curve, the market is telling us that it expects interest rates to come down over the next couple of years. Looking at the current inflation numbers, employment trends and overall growth, I believe the picture is one that should give the Bank of Canada reason to pause interest rate hikes, and one that should induce rate declines in 2024.

Given this view, I would not want to lock into a five-year fixed mortgage at 5.9 per cent. I think this rate will be lower in a year and much lower in two years. The problem is that a one-year fixed mortgage at 7.1 per cent doesn’t sound like much fun, especially if I am worried about cash flow.

If I did a one-year mortgage at 7.1 per cent on a $500,000 mortgage with a 25-year amortization period (I am using 25-year amortizations for all my analysis here), my monthly payments would be $3,533. This alone might push me to look at a longer-term mortgage if such a large monthly payment meaningfully impacted my overall budget.

However, if you could manage that payment, you would essentially break even if a year later you locked into a four-year mortgage at 5.55 per cent, which is about 0.55 percentage points lower than what you can get today. With that four-year mortgage, the monthly payments would be $3,019.59, so a fair bit lower.

If I had to guess, you might see a four-year mortgage at maybe 4.8 per cent a year from now. Keep in mind that five-year rates have gone up more than 3.5 percentage points in the past two years. Do we really think it is unrealistic to see a four-year mortgage rate drop 1.3 points over the next year?

In that scenario, if you locked into a one-year mortgage at 7.1 per cent and then locked into a four-year mortgage at 4.8 per cent (a monthly payment of $2,807.72), as opposed to simply locking in for five years at 5.90 per cent, the net impact would be the following:

Total payments over five years would be $177,166.70 vs. $190,162.35, or roughly $13,000 less. At the end of the five years, the principal paid off would be $52,899.37 vs. $51,453.45, so $1,446 more paid off, while spending $13,000 less.

Ultimately, what matters is your risk tolerance and your view on interest rates. If I was going into a fixed-rate mortgage, I might consider doing a one year and then locking in for longer a year from now. Of course, if I was doing a fixed-rate mortgage, it would largely be to avoid volatility and in that case, I might just lock in for five years.

HELOC vs. 5-year variable rate

The reasons I would probably look to move my entire mortgage to a HELOC now are that I don’t want to lock into anything at today’s rates, and I want meaningful flexibility. The other reason for the HELOC might be that at a time of higher mortgage payments, any way to lower cash-flow expenses would be of interest.

Let’s take the $500,000 example, and find a HELOC at prime, 7.2 per cent. This translates into a monthly charge of roughly $3,000. While I wouldn’t be paying down any principal, that may not be my No. 1 concern at a time of high inflation and tight budgets.  If interest rates do fall, the HELOC payments will also fall. At the same time, if the market changes, we may see greater discounts on five-year variable-rate mortgages.

A couple of years ago, not only was the prime rate so much lower, but many of these mortgages were as low as prime minus 1.1 per cent. Today, a good rate is prime minus 0.3 per cent.

If you are risk averse or think interest rates will keep rising, then lock in the best five-year fixed rate that you can. However, if you are willing to take on a bit of risk and think interest rates will fall, I would try to remain as flexible and exposed to variable rates for as long as possible and opt for a HELOC at this point.

Getting a good rate

We use mortgage brokers and a preferred partnership with our bank when a client is looking for a mortgage for themselves or one of their children. We do this because we want the client to be informed about what rates are available, and to at least have an option for the best bank rates. The key is not to simply sign off on the lender’s renewal request, as it is usually not the best rate they can offer you.

Ted Rechtshaffen, MBA, CFP, CIM, is president, portfolio manager and financial planner at TriDelta Financial, a boutique wealth management firm focusing on investment counselling and high-net-worth financial planning. You can contact him through www.tridelta.ca