While not the only factor to consider when choosing a mortgage, interest rates remain one of the more prominent decision criteria with any mortgage product. Understanding how mortgage rates are determined and the differences between your typical fixed-rate and variable-rate options can help you make the best decision to suit your needs.
How Rates Are Determined
The chartered banks set the prime-lending rate (the rate they offer their best customers). They base their decisions on the Bank of Canada’s overnight rate because it influences 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. When it comes to fixed-rate mortgages, banks use Government of Canada bonds. In the bond market, interest rates can fluctuate more often and provide clues on where fixed mortgage rates will go.
Simply put, a variable rate is based on the current Prime Rate and can fluctuate depending on the market. A fixed rate is typically tied to the world economy, whereas a 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 just entering the mortgage space.
The pros of this type of mortgage are that your payments don’t change throughout the life of the term. However, should the Prime Rate drop, you won’t be able to take advantage of potential interest savings.
Variable-Rate Mortgage
As mentioned, variable-rate mortgages are based on the Prime Rate in Canada. This means the interest you pay on your mortgage could go up or down, depending on the Prime. 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 Prime drop and interest rates lower, they would pay more to the principal instead of paying interest.
If the rates go up, they pay more interest instead of direct to the principal loan.
Other variable-rate mortgage holders will allow their payments to drop with Prime Rate decreases or increases should the rate go up. Depending on your income and financial stability, this could be a great option to take advantage of market fluctuations.
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Trish & The Primex Team