Borrowers are catching variable rate fever and the risks abound

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Variable rate fever is slowly spreading as more and more mortgage shoppers choose to float their rate, thanks to the Bank of Canada’s 175-basis-point rate slash bonanza.

But, like someone betting their retirement on a stock tip from their barber, these optimistic borrowers could potentially face hard decisions in 2025 if an alternate reality hits the fan.

Here’s what I mean.

Risks abound

First let me say, I couldn’t predict tomorrow’s weather if you paid me in gold bars, let alone rates one year out. Nonetheless, here’s what’s keeping some econo-psychics up at night:

• Inflation has been heading higher, partly due to a statistical quirk called base effects, and partly because of persistent underlying price pressures.
• Donald Trump’s cocktail of deregulation, tax cuts, immigration policy and tariffs is widely viewed as inflationary.
• Unemployment rate aside, North American employment and incomes keep marching upward — supporting spending — despite interest rates that our central banks deem “restrictive.”
• If bond yields vault over the 2024 highs, it could augur significantly higher rates.
• Short-sighted government spending sprees on both sides of the border could boost rates further.

All this runs counter to a reason hopeful variable-rate fans are choosing to float their rates. Variable-rate borrowers are operating on the assumption that Canada’s benchmark prime rate will keep dropping. That’s a correct assumption only if most economists and the bond market’s outlook is true, but it says nothing about how long rates will stay down.

As this is being written, traders are pricing in two to three more Bank of Canada rate cuts through next year. But here’s a little tip about future implied rate paths: they change. In fact, they may well change next week as we get forward guidance from the all-important U.S. Federal Reserve meeting, as well as critical inflation data on both sides of the border.

As for the hard decisions I mentioned, they come into play if core inflation starts heading back to three per cent or above. This is especially true for America’s core Personal Consumption Expenditures (PCE) inflation measure, which Federal Reserve chair Powell tracks like a forensic accountant.

For rate floaters, a return to three percent-plus core inflation would feel like watching a horror movie in slow motion. It would shake confidence of government bond holders, and U.S. yields would take flight. With a well-over-0.90 correlation between U.S. and Canadian five-year yields, Canada’s policy rate and mortgage rates would likely follow U.S. rates higher.

The degree of risk

Given Canada’s economy has more slack than a discount-store suit, and given that Trump tariffs could potentially decimate our growth, not many experts are worried about higher borrowing costs by the end of next year. But any homeowner getting a variable should understand that they’re a possibility.

If central bankers suddenly flip to a tightening bias, bond yields would surge, dragging fixed rates higher. Many floating-rate borrowers who think they can lock in if necessary would try to do so. But by that time, bond investors would have anticipated higher rates — and fixed rates would have run away from mortgagors — possibly by 50 to 75 basis points or more.

And that’s not to mention the fact that most lenders have crappy conversion rates to begin with when going from variable to fixed. Gone are the days when banks like HSBC routinely advertised transparent deep discount fixed rates that variable borrowers could lock into.

Of course, not locking in before an inflationary rate cycle could be even more costly than getting a lousy rate.

Pro tip: If locking in is your planned escape hatch, this is a critical question for your lender: Ask what rate you’ll get if you convert your variable to a fixed rate. Then ask for real-life examples using today’s pricing at that lender. Mortgage rates are subject to change but at least this will give you a sense for how competitive the lender is in the moment.

The trouble with rate locks is that timing rate cycle bottoms is like trying to predict where a penguin will waddle next. And your banker or mortgage broker is probably not going to be much help here because their crystal balls are no better than economists’.

All this is to say, counting on rates to keep sliding is like betting your life savings on a rain-free Vancouver summer. It might happen, but your budget better be ready for the storm if those clouds roll in.

As a parting tip, if you want to play the variable-rate game ahead of next year’s uncertainty and you don’t want as much payment risk, consider lenders with fixed payment variables. The best are the likes of Bank of Montreal and Canadian Imperial Bank of Commerce, which hold payments in check despite surging interest rates. This racks up more interest for the borrower and creates risk of higher payments at renewal, but at least it protects their monthly budget in the meantime. Plus, history shows rates typically fall back to earth after a few years.

Robert McLister is a mortgage strategist, interest rate analyst and editor of MortgageLogic.news. You can follow him on X at @RobMcLister.??

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This table reflects the prevailing rates at the time this story was published. For the best mortgage rates in Canada right now, click here.