Here’s Why I Am Holding Onto My Variable Rate

November 8, 2022

Key points:

  • We’re approaching the top of the interest rate hike cycle, and rates will likely decrease in the near future.
  • Converting to a fixed rate now means it will be very expensive to try and convert back into a variable rate in the future, once variable rates start going down.

Why I have decided to stick it out with my variable rate

In this video, I want to address the reasons why I’ve chosen to ride it out with my variable rate mortgage, instead of converting to a fixed rate. You can watch this video for a brief overview, and below I go into further detail on what’s likely to come.

Why I am holding onto my variable rate mortgage

There have been many adjectives to describe inflation in 2022…

Transitory.

Entrenched.

Sticky.

Stagflation… and my favourite: Greedflation.

Give it whatever spin you want, it’s painful. And the only medicine we have to cure it (rising interest rates) tastes awful. 

Reflecting back over the last 12 months tracking the narrative, it’s disappointing to see how misunderstood markets, central bankers, economists and talking heads (this broker included) got it in terms of trying to read what would happen next. 

It was unfathomable that by the end of the year we would end up with a retail prime rate over 6.25%. Yet, here we are. 

So what will happen next?

The Bank of Canada won’t reverse the trend on rates until a 2% target rate of inflation is achieved. 

They don’t care about the impact on our businesses and economies. 

They don’t care if it rains all over our real estate parade. 

They don’t care if we can’t make our mortgage payments and we default. 

They want to see a 2% rate of inflation. Full stop.

Why 2% is a purely academic discussion, but to explain the problem with entrenched inflation, let me buy you a coffee…

If a cup of coffee costs us $1 today and we have a 2% rate of inflation, it will take 36 years before that cup of coffee doubles in price to $2. 

With a 4% rate of inflation it will take 18 years.

And at our current rate of inflation ~7% it will take just 10 years for the cup of coffee to double in price. 

This is the power of compounding. The same compounding that makes your investments grow exponentially over a lifetime can work against us in an inflationary environment. Another way to express inflation is to say that the dollars you earn and save are worth less and less. So in 10 years at 7% inflation, your $10,000 of savings are only worth $5,000 in real terms. No bueno. 

Is the end of the rate hike cycle in sight?

Since June 2022 the headline rate of inflation has trended down, from 8.1% at the peak down to 6.9%. Sticky but headed in the right direction. 

At the same time there is a growing body of metrics showing that the rate hikes are having their desired effect to slow down the economy. In fact many economists believe the BoC has already overshot the mark and has triggered a technical recession. We just don’t have the data yet. 

Inflation metrics are a lagging indicator and only tell us what happened 6 months ago. Historically, every recession has been triggered by central banks being overzealous in their rate hikes, and markets seem to agree that we are now getting to that point. 

Looking forward…

Markets expect to see current rates stay static for the majority of 2023 before starting to decline. 

The amount of decline is really hard to predict because it depends on how deep the recession is, but it would be reasonable to expect at least a 1.00% decline to the prime rate to get us to neutral – an academic rate that neither stimulates nor restricts the economy. 

Why I’m staying in my variable rate mortgage

Personally, I continue to ride the variable rate wave (feels a bit more like a tsunami at times) with an understanding that history will repeat itself with lower rates on the horizon. The challenge is staying balanced and not falling off the board before we get there… I acknowledge that this is really difficult for households and not everyone is able to afford the higher payments. 

Converting into a fixed rate mortgage today between 5% – 6% will give you the benefit of a fixed payment but that hedge comes with a very high interest rate. Expect to experience FOMO within 12 months as rates start to drop, and you find that the penalty to refinance to take advantage of lower rates is too high. 

So, dig deep. Be patient. Change your spending habits (that’s what the Bank of Canada wants you to do) and ride the wave with me.

If you’d like to discuss today’s decision and how it relates to your mortgage, you can contact me here or schedule a convenient call time directly into my calendar below.