Whether you’re a homeowner looking to purchase another property or a first-time buyer, mortgage rates can affect your investment if you plan to take out a loan. Understanding interest rates is key to making the right financial decisions.
Mortgage rates in Canada depend on several factors, such as the general economic state and your status. You might make poor financial decisions without a basic understanding of mortgage rate trends.
Learn about mortgage rates and the factors that determine the rate you may receive when purchasing a home.
How Are Mortgage Interest Rates Determined?
The interest rate charged by banks depends on various factors, such as the state of the economy. Each bank in Canada sets its own prime rate, and the major banks usually have the same number. The prime rate Canada banks offer is influenced by the Bank of Canada’s “policy interest rate,” also known as the “target for the overnight rate.”
Central banks, such as the Bank of Canada, tend to raise interest rates when inflation is high to discourage borrowing and reduce consumer demand. The Bank of Canada has the power to raise the overnight rate, which makes it more expensive for banks to borrow money. So, banks can increase their primate rates to cover the extra costs and charge borrowers a higher interest rate.
Types of Interest Rates
The two most common types of interest rates that affect a borrower’s costs when getting a mortgage are fixed and variable rates.
A fixed-rate mortgage remains the same for the life of the mortgage. This rate is easy to calculate and stable. Borrowers who want to know what their future costs would look like often opt for this mortgage rate. A fixed rate is also beneficial when you receive a low-interest rate. It allows you to lock that rate throughout your amortization period and reduces the risk of incurring unexpected costs if the interest rate fluctuates.
2. Variable Rate
A variable-rate mortgage can fluctuate as interest rates change. It is usually tied to the movement of base interest rates, such as the prime rate. If interest rates go down, borrowers can enjoy the benefits of a lower mortgage cost. However, if the interest rates rise, borrowers will incur a higher cost.
According to the Canada Mortgage and Housing Corporation (CMHC), there was a downtrend in fixed mortgage rates at the end of the first quarter of 2022. The considerable discount between fixed and variable rates drove more borrowers to opt for variable-rate mortgages. As a result, over 40 percent of new mortgage balances issued in the second quarter of 2022 have variable rates.
Factors Influencing Interest Rate
The funding cost of a mortgage is primarily driven by interest rates in Canada and many other regions, so the rates can fluctuate for a few reasons.
1. Economic Growth
Strong economic growth results in higher interest rates, whereas weak economic growth leads to lower interest rates. When the economy is strong, more individuals or businesses are capable of borrowing money, leading to increased rates. On the other hand, a weaker economy makes it challenging for people to seek a loan, lowering interest rates.
Canada has one of the largest economies in the world, and the country’s gross domestic product (GDP) is expected to continue rising according to projections until 2027. Although the global pandemic affected the country’s GDP in 2022, the economy bounced back and continued to offset the losses. The boost in the economy allows banks to charge a higher interest rate on loans.
2. The Bank of Canada’s Rates
The Bank of Canada affects interest rates through changes in its policy rates. When the economy is strong, they raise the rate to keep inflation from rising. Similarly, they lower the rate when the weak economy keeps inflation from falling below the target.
3. Your Personal Circumstances
Your circumstances and financial status play critical roles in your interest rate. Banks may offer you a lower interest rate if you can pay a larger down payment or have a good credit score. On the other hand, if you make a smaller down payment or don’t have a reasonable credit score, banks may trust your ability to pay back the loan and charge you a higher interest rate.
Establishing good credit behaviors allows Millennials to improve their chances of buying a home. Equifax Canada conducted a generational survey in 2018 that tracked individuals’ credit scores of various ages for an entire decade. The results revealed that the youngest age group saw an increase in their credit score over the years, while other age groups have witnessed a small decline over the same time frame.
How do Interest Rates Affect Your Purchase?
Interest rates can play a significant role in your purchase as they could affect your affordability.
1. Determines Your Monthly Payments
The mortgage rate a lender offers can influence your monthly payment amount. Whether or not your interest rate is fixed or variable also determines your monthly costs. If interest rates rise, you can protect yourself by asking your lender if they offer an interest rate cap or a convertibility feature.
An interest rate cap sets the maximum interest rate your lender can charge on a mortgage, protecting you from high rates. A convertibility feature allows you to convert or change your mortgage to a fixed rate, but it usually involves a fee.
2. Affects Your Purchasing Power
The interest rate may also affect your purchasing power. As rates go up, your affordability may decrease because raising interest rates makes borrowing funds more expensive. With every one percent increase in interest rates, your buying power decreases by about 10 percent.
3. Influences Home Equity Loan
A home equity loan is a second mortgage that allows you to access real estate equity. Home equity loans allow you to borrow money against your home, depending on the available equity. Since home equity loans come with interest rates, understanding the rate trends is a great way to decide whether or not you should use your home equity for a second loan.
Value of Interest Rates in the Housing Market
Interest rates play a critical role in the housing market as they can determine a borrower’s purchasing power, affordability, and monthly expenses. Understanding Canadian mortgage rate trends will allow you to become an informed buyer and make educated decisions when buying a home. Learn about mortgage rate trends and determine how it plays a role in your purchase to avoid unexpected costs.