Mortgage Interest Rate

04.jpg

Rates are either locked in or floating. Locked-in rates are referred to as “fixed rates”. Floating rates come in two flavours: “variable” and “adjustable”.

Locked-in or Fixed rates are unchanged over a contract duration. They fluctuate in tandem with bond rates that are set by financial markets. Many people mistakenly believe that the government sets bond rates, but this isn’t true.

Floating mortgage rates are calculated monthly using the Prime Rate; the industry term for this type of interest is Variable Rate Mortgages (VRM) or Adjustable Rate Mortgages (ARM).

The Prime Rate is a floating rate set by each bank that can change monthly so that the interest charged on a floating rate mortgage can vary monthly even though the monthly payment stays the same.

The mortgage payment on a VRM is set at the beginning of the contract term based on the beginning contract rate and then stays fixed for the contract term.

When a floating interest rate increases (or decreases) with the Prime Rate, the amount of your mortgage paid down changes downward (or upward). Below is an example using a $500,000 mortgage to illustrate the impact of a rate change.

VRM Table.jpg

In a rising interest rate environment, this might result in a borrower falling behind on their loan repayment during a contract term and then having to make up the difference in the subsequent term by increasing their payments.

Benefits of Locked-in vs. Floating

05.jpg

When you agree to a fixed interest rate, the interest rate will not change for the duration of the contract, so you can accurately predict how much interest you will pay over the term.
With a floating rate, you set constant monthly payments, but the interest rate may change, so you won’t know precisely how much will be paid off at the end of the term.
An adjustable-rate mortgage (ARM) increases/decreases your regular mortgage payment as interest rates change to keep your repayment schedule on track.

Key Facts:

  • 2 in 3 Canadians choose fixed-rate mortgages.

  • For fixed-rate mortgages, a longer term will usually have a higher interest rate.

  • For floating rate mortgages, a longer term will usually have a lower rate.

Pay close attention to the floating rate quoted by lenders because not all lenders use the same “Prime Rate” rate. Some lenders have a higher prime rate specifically for mortgages. For example, at the time of writing this article TD Mortgage Prime Rate was 0.15% higher than the regular TD Prime Rate used for other floating loans. The difference between the two is small but significant. Over the course of a year the difference in rates could save you hundreds of dollars.

Like this information? Like us on Facebook.