Recently the Bank of Canada warned that interest rates will start rising sooner than expected, as inflation pushes up prices for food, fuel, consumer goods and housing.

A report by Douglas Porter and Robert Kavcic at BMO Economics says that with inflation surging in many countries, markets are now pricing in almost four interest rate hikes by the end of 2022. Some observers believe the first rate increase could happen in April 2022, whereas the Bank of Canada had previously indicated that rates would be on hold until 2023.

In the first half of 2021, mortgage debt grew faster than any time in the last decade, according to Canada Mortgage and Housing Corp. (CMHC). It says record-low interest rates and shifting housing needs caused by the pandemic were responsible for the growth in mortgage debt.

Yet mortgages in arrears in Canada reached a 30-year low. At the beginning of the pandemic, lenders provided more than 800,000 borrowers with mortgage payment relief, allowing them to delay or make reduced payments for a predetermined amount of time. CMHC says when the economy began opening up, most borrowers were able to resume their payments.

“The downward trend in mortgage arrears in 2020 (non-payment for 90 days or more) continued into the first quarter of 2021, reaching lows that were last observed in 1990,” says CMHC. “Overall consumer payments increased and the growth in disposable income remained positive, which helped Canadians to make their monthly mortgage payments on time.”

However, the housing agency says early-stage delinquency rates (overdue by 30 days) are up and could lead to more mortgages in arrears in the coming months.

CMHC says the downward trend in fixed mortgage rates “seemed to hit a bottom at the end of Q1 2021, while the Bank of Canada held the overnight rate at 0.25 per cent.

“In June 2021, the average variable mortgage rate was 59 basis points below the average fixed rate for uninsured mortgages with terms of five years or more,” says CMHC. “This deep discount drove more borrowers to opt for variable-rate mortgages. Over 40 per cent of new mortgage balances issued in the second quarter of 2021 have variable rates, including one out of four insured mortgages and almost half of uninsured mortgages. In both cases, these are above the average shares of the last eight years and much higher than the respective five per cent and eight per cent recorded in February 2020, before the start of the pandemic.”

But rates for both variable and fixed mortgages are expected to rise soon.

“The age-old question of whether to lock into a longer-term fixed mortgage rate or stay in a variable rate has become an increasingly complex and important issue recently, with short-term rates at extreme lows and pressure building quickly for higher rates in the year ahead,” say Porter and Kavcic. “Historically, there is little debate which has been the better option: Typically, borrowers save money by staying in variable products and riding the rollercoaster of fluctuating rates.”

The economists say that since 1975, the variable rate option has proven most cost-effective 70 per cent of the time. But in the current environment, the right choice isn’t as clear.

“The inflation flare-up could force the Bank of Canada to raise interest rates aggressively, driving variable rates higher, but leaving fixed-rate choosers unscathed,” say Porter and Kavcic. “Considering the likely upward trend in interest rates, this may be a rare period when a fixed rate turns out to be the superior choice.”
Fixed-rate mortgages offer borrowers peace of mind “in what could be a volatile period ahead for interest rates,” they say. With the Bank of Canada’s overnight rate bottoming out, there’s no further room for variable rates to drop – they can only go up. “This is clearly one of those rare times when fixed rates may prove to be a cheaper alternative.”

Every choice has some risks, however – the biggest one being that those who lock into a fixed rate may see those rates drop further if the economy tanks.

Those who decide to stick with the cheaper variable rate for now can always lock into a fixed rate later if rates start climbing.

If you’re looking for a home, getting a mortgage pre-approval is a good idea. Most lenders will hold the pre-approved rate for 120 days, providing some protection against rising rates. In the current market where there are few listings available in many communities across the country, having a pre-approved mortgage can also give buyers an edge when there are multiple offers on a home.