When you shop for a home— especially for the first time— the mortgage process can be dizzying. Lenders and realtors throw out terminology that you might not readily understand. All those acronyms and financial concepts become clearer as the home buying experience moves along, and interest rates are one component of a mortgage you absolutely need to grasp.
Fixed vs Variable Rate Mortgages
Before you sign on the dotted line, decide which type of mortgage fits your needs and budget. A fixed-rate mortgage locks in an interest rate for the duration of the home loan. Unless you refinance, that rate will not change. Fixed mortgage terms, or the length of the loan contact, range from one year to 10 years and interest rates will run higher as you opt to pay for longer periods of time. Homebuyers choose fixed mortgage rates when they want to know exactly how much principal and interest they will be paying per month, and for how many months.
Over the life of the loan, variable rate mortgages, as the name suggests, will see rates rise or fall from the negotiated initial rate. The structure of a variable home loan differs from lender to lender, but a starting interest rate may stay the same for a year. After the initial rate period, the financial institution has the option to increase or decrease the rate dependent on a few different factors.
How Rates Are Determined
Mortgage rates— and indeed all interest rates— are pegged to a financial measure that is influenced by inflation. In Canada, mortgage rates move in lock-step with rates on Canadian government bonds, and bond rates hinge on the overnight rate that banks charge to lend money to each other. Interest rates on those bonds move up or down dependent on forecasters' outlook on the economy. Strong demand for goods and services tend to push costs up, and weak consumer spending and business investment puts downward pressure on prices.
Your personal interest rate will generally fall in a prescribed range but the amount applied as a down payment and credit score has a significant influence on the rate you will receive. Upfront, variable rates typically sit below fixed rates but as we've discussed, that can change if overall rates rise.
What Works Best for You?
Choosing a fixed rate in a low-interest-rate environment is a no-brainer. Some folks have been lucky enough to sew up a long-term mortgage in the last 11 years when rates have run at 3% or below. Even refinancing out of a closed five-year term hasn't subjected any creditworthy borrower to interest rate sticker shock. Rates have moved up a bit in the past 18 months but nowhere close to the double-digit figures of the 1980s.
A variable-rate mortgage may hold appeal if you feel interest rates will reverse course and fall. With that philosophy, you may renegotiate out of a one-year variable agreement and pay less than current obligations in principal and interest.
Educating yourself and finding a reputable mortgage counsellor goes a long way toward navigating the home buying or refinancing process. In addition, keeping close tabs on the direction of mortgage rates will help you decide whether it's time to buy or wait it out. Rates.ca gives home buyers an easy means to compare rates from a variety of lenders across Canada.