While not the only factor to consider when choosing a mortgage, interest rates continue to be one of the most prominent decision criteria for any mortgage product. Understanding how mortgage rates are determined and the differences between typical fixed-rate and variable-rate options can help you make the best decision to suit your needs.
HOW RATES ARE DETERMINED
Banks set the prime-lending rate (the rate they offer their best customers), which is influenced by the Bank of Canada’s overnight rate because it impacts their own borrowing. Approximately eight times per year, the Bank of Canada makes rate announcements that could affect your mortgage, as variable mortgage rates and lines of credit move in conjunction with the prime-lending rate. For fixed-rate mortgages, banks use Government of Canada bonds. In the bond market, interest rates can fluctuate more often and can provide clues about where fixed mortgage rates will go next.
To put it simply: a variable-rate is based on the current Prime Rate and can fluctuate depending on the markets. In contrast, a fixed-rate is typically tied to the world economy, whereas the variable rate is linked to the Canadian economy. When the economy is stable, variable rates will remain low to stimulate buying.
FIXED-RATE VS. VARIABLE-RATE
Fixed-Rate Mortgage
First-time homebuyers and experienced homebuyers typically love the stability of a fixed rate when entering the mortgage space.
The pros of this type of mortgage are that your payments don’t change throughout the term. However, if the Prime Rate drops, you won’t be able to take advantage of potential interest savings.
Variable-Rate Mortgage
As mentioned earlier, variable-rate mortgages are based on the Prime Rate in Canada. This means that the amount of interest you pay on your mortgage could go up or down, depending on the Prime Rate. When considering a variable-rate mortgage, some individuals will set standard payments (based on the same mortgage at a fixed rate). This means that, should the Prime Rate drop and interest rates lower, they would end up paying more to the principal as opposed to paying interest.
If the rates go up, they will simply pay more interest instead of directly reducing the principal loan.
Other variable-rate mortgage holders will allow their payments to decrease with Prime Rate decreases or increase should the rate go up. Depending on your income and financial stability, this could be a great option to take advantage of market fluctuations.
Want to learn more about rates or need mortgage advice? Contact your mortgage expert today!