So how does a drop in the prime lending rate effect you? Since the two rate drops to the prime lending rate in January and July 2015 I have had many calls about what the change means and what to do next.
Any changes to your variable rate mortgage will happen only if the Bank of Canada chooses to change the overnight lending rate which in turn prompts the lenders to reset their prime lending rate (which affects variable rate mortgages and lines of credit).
How Does a Drop in the Prime Lending Rate Affect You?
First, the Bank of Canada meets 8 times each year.
The schedule for 2015 is: Jan 21st, Mar 4th, April 15th, May 27th, July 15th, Sept 9th, Oct 21st and Dec 2nd.
Regardless of any potential movement in the overnight and prime lending rates, as always I recommend to my clients to refer back to your original decision to choose a variable rate mortgage. If you have been following your plan and strategy to maximize the variable rate option — a shift upwards in the rate will likely not have a major impact to you. After each change in the prime lending rate you should check with your broker or lender to confirm your payment. When rates dropped the payments automatically dropped. If you want to maintain the same payment you have to direct your lender to make the change.
Remember – it is up to you if your goal is to lower your cost of borrowing and maximize the pay down of your mortgage OR if you want to find a cost effective balance between managing debt and investing the difference to maximize your financial portfolio. Then you can set your payments accordingly.
If lowering your cost of borrowing is your goal, set your payments higher than your current variable rate. I recommend setting your payments at the level of a 5 year fixed rate and if there is space in your prepayment option (lender specific) you can further increase the payment OR set up a lump sum payment each year to maximize your pay down.
If your goal is to find a cost effective balance, you should determine the sweet spot where each payment pays down more principal than interest (25 years or lower amortization) and invest the money you would have put against the mortgage into a higher yield option.
Both of these approaches should be discussed with your financial planner and mortgage broker.
If your not sure whether you should stay in a variable mortgage or not, consider this…
If your variable rate mortgage is up for renewal in the next 12-24 months any increase to the prime rate will be offset by the savings on interest you enjoyed in the first 24-36 months of your mortgage. If you have been paying interest of 2.4% or less while 5 year fixed rates have been between 2.69%-3.09% your savings will exceed any potential extra cost of borrowing in the final 12-24 months if rates were to rise near the end of your mortgage term.
If your variable rate mortgage is up for renewal beyond 2 years from now you might consider locking into a fixed rate. Or you may choose to ride it out if you are maximizing your payment options. This decision would depend on the mortgage amount, the current variable rate, your plans for moving or staying in the home and other factors. Your mortgage broker can review your needs and run the numbers to help you make an informed decision.