Is a Short-Term Mortgage the Way to Go?

Let’s face it: The mortgage market is notably volatile right now. And Canadians are noticing.

The 2023 RE/MAX Housing Market Outlook report revealed that nearly half (45 percent) of Canadians are concerned that additional interest rate increases will affect their ability to purchase or sell a home this year.

After the Bank of Canada (BoC) announced that it would slam the pause button on raising interest rates, it appeared that the mortgage sector would stabilize and provide prospective homebuyers certainty on where fixed- and variable-rate mortgages would be headed.

What a difference a month can make!

The chaos in the bond market – Canada and the rest of the world – has potentially changed the direction of these debt instruments. Remember, the five-year bond yield is typically the basis for most mortgage rates. As of Mar. 16, 2023, the five-year bond was trading at around 3.07 percent. And, of course, the central bank’s policy decisions influence the bond market.

Last year, the conventional five-year mortgage lending rate was around 3.77 percent. It is above 5.8 percent today, according to the Canada Mortgage and Housing Corporation (CMHC).

At the beginning of the year, there had been a debate about whether rates would trend higher or lower. While market experts have carved out a path for the economy this year, the latest events in the financial system have cast doubts on these projections. Based on the recent developments, it could be challenging to figure out how interest rates, the bond sector, and even the Canadian real estate market will evolve in the coming months.

So, what is the solution for a household considering purchasing a detached house in rural Ontario or a condominium suite in the heart of Vancouver? It may be time to think about short-term mortgages.

Is a Short-Term Mortgage the Way to Go?

The BoC signalled that it would leave interest rates elevated for quite some time to conquer inflation and determine how they are affecting the broader economy. If the central bank does follow through on this pledge, this could be good news for borrowers as they now possess some certainty about the future.

However, what happens if the central bank starts cutting interest rates in response to a slowing economic landscape? Indeed, it could force homebuyers to leave savings on the table as they finally dip their toes in the Canadian housing market. This is undoubtedly a difficult decision to make.

A chorus of economists and mortgage experts assert that a legitimate solution is to take on short-term mortgages, be it one- or three-year terms. By employing this option, you can lock in mortgage rates that are just below the peak, and then, over the next 12 to 36 months, you can renegotiate your mortgage and obtain a lower interest rate. As a result, your monthly payments would shrink earlier than if you wait for the full five-year fixed rate.

Meanwhile, others purport that taking advantage of a variable-rate mortgage in this environment could also be advantageous since rates are more likely to come down than they are to rise.

“Yes, five-year fixed mortgages have materially lower rates right now, but that’s largely because Bank of Canada rate cuts are just starting to be priced into five-year terms. Barring another unforeseen inflation spike, variable and short-term rates will ultimately fall below five-year fixed rates, potentially by next year,” The Globe and Mail wrote.

“Regardless of expectations, the market compensates borrowers for taking risk. Over a five-year span, the risk-reward of taking back-to-back one-year fixed mortgages remains favourable. The fact that today’s one-year rates are so much higher doesn’t change that.”

Of course, at the same time, it is important to note that everyone’s balance sheet and personal finances are different. Some might have substantial down payments. Others may have a highly leveraged and costly residential property. A few may be willing to heed the market signals and go with a variable option. Whatever the case may be, it is always crucial to speak with a real estate agent and mortgage specialist at your lender.

At its next policy meeting in April, money markets are pricing in a 40 percent chance of the central bank cutting interest rates.

“Obviously, just as easy as this has changed over a weekend, that may change back, but that’s kind of the expectations given the current situation,” Shubha Dasgupta, CEO of Toronto-based digital mortgage agency Pineapple, told Global News.

With Canada’s annual inflation rate falling below six percent for the first time in February 2022, these could be good odds.

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