Now is likely not the time for a 5-year Fixed Rate Mortgage

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Now is likely not the time for a 5-year Fixed Rate Mortgage

Matthew Robinson • February 13, 2023

Here’s why you should avoid the temptation of going long term fixed right now.

For most, the bond market doesn’t make the best cocktail party conversation. But if you’re shopping for a mortgage, knowing something about it can pay off.

The bond market would be the smartest “person” in that room and sees things that most mortals don’t. When dealing with mortgages and rate forecast predictions, a common saying is that no one has a crystal ball. The bond market would be the closest thing to that proverbial crystal ball as it often does tell the future. Or at least, it tells the future about interest rates more accurately than probably 99.9% of the general population.

It can do that because investors in the bond market—those with the best information—bet billions of dollars on where rates are headed in the next minute, week, month and year. They make those bets with a full understanding of inflation, GDP (gross domestic product), the business cycle, and all the other fun stuff that goes into determining mortgage interest rates.

For all but a few bond gurus, it’s almost impossible for anyone to know more about where interest rates are headed than the consensus forecast of financial markets. That’s why people rely heavily on the bond market for clues on the path of rates.

In financial markets swayed by random events, nothing is absolute. But here are four scenarios where the bond market is a fairly reliable mortgage indicator.

#1: When 10-year bond yields are below 2-year bond yields

This is what bond professionals call an “inverted yield curve.” It’s an unusual phenomenon because rates on long-term bonds are normally higher (since investors want to be compensated more for the risk of lending long term).

Inverted yield curves, like the one we’re witnessing today, are a high-probability signal of a coming recession. Recessions are universally bearish for mortgage rates, meaning they always pull down rates eventually. That’s a good thing if you’re floating your mortgage and a bad thing if you’re locked into a high fixed rate.

Inverted yields provide the strongest signal after multiple Bank of Canada rate hikes. At that point, rate cuts are usually less than 12 months away on average.

#2: When prime rate is well above its 5-year average

When Canada’s prime rate is over 50% above its 5-year average, like it is today, variable rates have outperformed 5-year fixed rates ~94% of the time. By outperform, I mean they cost less in interest over five years.

Note: This data goes back to 1944 and ends January 2018. Prime rate is used as a proxy for the variable rate prior to 1981, when variable rates first appeared.

This pattern is not precise, however. November 1979 is the one counter-example where floating rates surged 7.75 percentage points in just 21 months after prime rose 50% above its 5-year average.

Nonetheless, if you’re financially stable and like to play the odds, this is one of the safer bets you’ll get in the mortgage market. Just be sure you can handle your payments if inflation surprises and doesn’t fall below 3% fast enough. (3% is the top end of the Bank of Canada’s target range.)

In that case, the Bank may have to take rates even higher.

#3: When the Bank of Canada (BoC) increases rates after several previous hikes and the 5-year bond yield drops

Most people think that BoC rate increases are bad for mortgage rates, and that’s true for variable rates in the short term. But once the BoC boosts its policy interest rate multiple times and the economy starts to slow, the bond market (which anticipates the future) starts predicting rate cuts.

Bond yields—which drive fixed mortgage rates—then fall.

If they fall materially, it’s usually a sign that interest rates have peaked for at least a year or two, but typically much longer.

#4: When the 5-year government yield surges 20+ basis points

In the short term, swings in bond yields can move fixed mortgage rates. If you’re not closing for 60 days, for example, and bond yields are diving, you may want to wait to lock in. That way, you can get the best available rates and not have to rely on your lender to lower your rate after you’ve already committed.

On top of that, there are often better deals on rates if you only ask for a 30-day rate guarantee. This is especially true if the mortgage is default insured (e.g., you’re making less than a 20% down payment).

Related tip: If you can, allow yourself at least 30 days to close. This reduces stress given there are multiple steps in the approval and closing process.

The takeaway:

Based on what the bond market is currently telling us, now is not the time to lock into a 5-year fixed rate near or above 5%.

Of course, nothing is foolproof when it comes to predicting financial markets. When using rules of thumb like the ones above, no one should expect perfect timing.

Either way, heeding these tips will give you an edge—both in rate timing and in mortgage term selection.

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A Guide to the Cascade Mortgage Strategy

By Matt Robinson • March 7, 2025

In a declining interest rate environment , smart homeowners aren’t waiting for their mortgage renewal to take action—they’re locking in savings now. The Cascade Mortgage Strategy is a tactical approach that lets you progressively lower your borrowing costs while protecting against future rate hikes. Instead of sitting on a fixed rate for an entire term, you prepay portions of your mortgage and reset them at lower rates as they become available. This setup provides a practical framework for implementing the Cascade Mortgage Strategy, allowing you to make strategic prepayments while maintaining a sufficient buffer for emergencies and other financial needs. Here's how it works. For the sake of this illustration, let's assume you own a property valued at $1,000,000. You require a mortgage of $500,000. We set up a home equity line of credit (HELOC) on top of this for $150,000. Property Value: $1,000,000 Mortgage Amount: $500,000 HELOC Limit: $150,000 Annual Prepayment Privileges: 20% of the original mortgage balance annually ($100,000) Initial Setup: Work with us to secure a $500,000 mortgage on your $1,000,000 property, ensuring you have a $150,000 HELOC in place. This gives you a $650,000 overall credit limit. We must ensure the lender offers flexible prepayment privileges, allows for multiple mortgage components, and provides the option to re-amortize your mortgage after each prepayment. Step-by-Step Process: At the end of the first year, use the HELOC to make a 20% ($100,000) prepayment on your mortgage, reducing your balance from $500,000 to $400,000. Immediately reset the $100,000 HELOC balance into a new mortgage component, ideally at a lower interest rate than your original mortgage. Rinse and repeat annually. After each prepayment, you have the option to either reduce your monthly payments or maintain them at the original level. If you choose to reduce the payments, this will improve your cash flow each month. Alternatively, by keeping your payments consistent, you'll accelerate the reduction of your principal, allowing you to pay off your mortgage more quickly. Interest Rate Decline with Each Prepayment This strategy obviously works best in a declining interest rate environment. However, even in a relatively stable interest rate environment, the strategy still offers benefits by improving cash flow and accelerating principal repayment. Each year, after making the prepayment, the homeowner resets the $100,000 HELOC balance into a new mortgage component with a lower interest rate. The decline in interest rates is attributed to both market conditions and the shorter terms selected for the new components. End of Year 1 - The new 4-year term rate is 4.25%, a 0.75% decrease from the original 5% rate. End of Year 2 - The new 3-year term rate is 3.50%, another 0.75% decrease from the Year 1 rate. End of Year 3 - The new 2-year term rate is 3.25%, a 0.25% decrease from the Year 2 rate. End of Year 4 - The new 1-year term rate is 3.00%, a 0.25% decrease from the Year 3 rate. These declines reflect both a general reduction in market rates and the typical savings associated with selecting shorter-term mortgages at each interval. The Results To truly appreciate the benefits of the Cascade Strategy, it's important first to understand what happens when this strategy is NOT employed. In a typical mortgage scenario, a homeowner with a $500,000 mortgage at a 5% interest rate, amortized over 30 years, would make consistent monthly payments over the term of the mortgage. After five years, the numbers look like this: Total Payments Made: $160,107.00 Total Interest Paid: $118,915.80 Principal Paid: $41,191.20 Outstanding Balance (end of term): $458,808.80 In this scenario, a significant portion of the homeowner's payments goes toward interest, with relatively modest progress in reducing the principal balance. Now, let's consider the same homeowner, but this time, they implement the Cascade Strategy. By the end of the five-year term, the results are notably different: Total Payments Made: $160,107.00 (unchanged) Total Interest Paid: $105,618.23 Outstanding Balance: $445,511.23 Principal Reduction: $13,297.57 Net Effective Rate: 4.45% (0.55% Reduction) The total interest paid with the Cascade Strategy is $105,618.23, which is $13,297.57 less than what would have been paid without the strategy. This reduction in interest costs is a direct result of leveraging lower interest rates on the newly created mortgage components, which are set up after each annual prepayment. By the end of the five-year term, the outstanding mortgage balance is $445,511.23, compared to $458,808.80 without the strategy. This $13,297.57 reduction in the outstanding balance indicates that the Cascade Strategy not only saves money on interest but also accelerates the repayment of the principal. This means that homeowners using this strategy are closer to paying off their mortgage sooner, reducing the overall term and financial burden. This case study demonstrates that the Cascade Strategy can be an effective and powerful tool for homeowners looking to optimize their mortgage and improve their financial outcomes. By strategically making prepayments and resetting those amounts into new mortgage components at lower rates, homeowners can achieve substantial interest savings, accelerate their mortgage repayment, and reduce their outstanding balance—all without increasing their total monthly payments.