Interest rates 101
Interest rates vary hugely, even from one day to the next. It’s really important to spend some time locking down the very best rate. One of the easiest ways to do this is to employ a mortgage broker who can act as an entryway to a variety of lending institutions – banks, credit unions and suchlike. A mortgage broker can shop around for you – perfect for helping you find the right rate and mortgage options.
When you’re dealing with interest rates on large amounts of money, even a variance in interest rates as small as an eighth of a percent can make a significant difference to your repayment amount. Typically, the interest is also calculated over long time periods, which makes it even more important to secure the best possible rate.
To complicate things further, there are also different types of interest and mortgage rates. This can make it difficult to know if you’re comparing apples to apples, or apples to oranges.
A fixed rate means that your interest rate remains the same (fixed) for the entire term (duration) of the loan.
Generally, this means the percentage of interest will be a little higher, since the lending institution may be losing money in the future if interest rates rise.
A fixed rate loan provides the buyer with the security of knowing that the cost of their interest will remain the same over time. This means your payment and the amount that goes towards reducing the principal (original loan amount) will remain the same over time as well.
A variable rate means the percentage of interest that you are repaying will vary based on changes in the interest rate(s) of the overall market.
Typically, fluctuations in your interest rate will not alter your monthly payment. But, they will vary the amount of your monthly payment that goes towards reducing your principal (original loan amount). This means if overall interest rates go down, you’ll actually be paying off your loan more quickly.
On the other hand, if interest rates increase, you’ll be paying off your loan more slowly. Accepting a variable rate does involve a certain amount of risk, but it can work to the buyer’s advantage in the long term.
A protected variable rate is similar to a variable rate in that the interest rate will vary over time based on market fluctuations. The difference is that a maximum interest rate has been written into the loan contract, meaning that if market interest goes above a set percentage, the buyer only has to pay the agreed-upon maximum. This minimises some of the risk involved in a variable rate loan.
In addition to the standard choices listed above, some loans offer a convertible rate option that enables the buyer to change to a fixed rate without incurring any penalties. Many variable rate and short-term fixed-rate loans are presented with a convertible option.
Buying a home is a huge financial and lifestyle commitment. Whether you’re a buying your first home, upgrading to a larger, more expensive home, purchasing a rental property, or looking for a vacation property, there are many options to consider.
You need to ask yourself if this is the right time for you to buy. Making a careful assessment of your current situation can help you to make that decision, but you also need to consider your community’s current economic circumstances.
‘Open’ vs ‘closed’ mortgage types
In addition to the interest type, the mortgage type or term of the mortgage can have a significant impact on your monthly payment figure, as well as the level of interest you’ll pay on the principal. The term, or length of time over which a loan is paid back, can vary from as little as 6 months to as long as 15 to 20 years. Once the end of the term is reached, the mortgage can be renegotiated if the buyer chooses.
There are two common mortgage types – “open” and “closed”. Let’s find out more below…
An open mortgage means that the loan can be paid back partially, or in full, without incurring any penalties. The mortgage can also be renegotiated if there’s a change in market conditions or your financial situation.
Although an open mortgage provides more options and opportunities for life adjustments, this comes at a cost, as the interest rates for this type of loan tend to be higher. However, for those able to make larger payments, or who plan to sell their home within a short period of time, an open mortgage can be a solid choice.
The advantage of a closed mortgage is that interest rates tend to be lower, but options are also limited. Typically, a homeowner may make extra payments or larger payments as long as the sum of the payments does not exceed a set amount determined in the loan agreement. Payments exceeding the agreed-upon amount would incur penalties.
Payment frequency options are another part of the property ownership puzzle. Property owners can save a significant amount on interest paid over their loan term depending on their cash flow, the amount of each payment and the number of payments per year.
The most common frequency type is the monthly payment option. With a monthly payment, the payment is typically due exactly one month from the day on which your mortgage started. In many cases, however, the actual due date can be changed to a more memorable or convenient date, such as the 1st or 15th of the month.
With a semi-monthly option, the buyer makes two payments per month. Generally, the payments would be due on the 1st and 16th. This option allows you to make your payments in smaller amounts and may help to keep your cash flow consistent across the entire month, rather than having a large payment due out of a single paycheck.
As with the semi-monthly payments, the accelerated bi-weekly option allows you to make smaller but more frequent payments. With this option, you’ll make a payment every other week and this means that twice a year you’ll make three payments instead of just two. This will increase the speed at which you repay your loan.
Another option is to make a weekly payment, which means there are five times during the year when you would make five payments instead of four. This option is another way to keep your cash flow consistent.
Your payment frequency option could save you money in interest by enabling you to pay off your mortgage sooner. CompareMyRates.ca mortgage calculator can help you determine the impact of the different options on your interest due.
A few things to consider before a property purchase:
- The amount you can afford to spend
- Renting versus owning
- The size of the mortgage payment in relation to your budget
- Interest rate, and;
- Mortgage options
You’re probably starting to think about the wide variety of mortgage solutions and payment options available and how they can be used to meet your needs.
CompareMyRates.ca has gathered information for home buyers that’s designed to help you make the right decision for you. Our helpful information tools are provided at no cost to ensure that you’re able to make a suitable, well-balanced decision that you feel comfortable with. Our tools will help you decide on the best options.
How much do I qualify for?
If you’re ready to purchase a new home, one of the first things you want to find out is how much you’re qualified to borrow. Lenders have restrictions on the amount of money that a lender can borrow that are based on the borrower’s income and current debt.
GDSR: Gross Debt Service Ratio and TDSR: Total Debt Service Ratio
To determine the amount that you’re able to borrow, a lender will take into account your gross household income, your down-payment and your mortgage interest rate. Lenders will also consider your existing assets and liabilities.
The rules governing these two factors – Gross Debt Service Ratio (GDSR) and Total Debt Service Ratio (TDSR) — are overseen by Canada Mortgage and Housing Corporation (CMHC). CMHC is Canada’s national housing agency and this country’s premier provider of mortgage loan insurance, mortgage-backed securities, housing policy and programs, and housing research.
GDSR states that your monthly housing costs should not exceed 32% of your gross monthly household income. Housing costs include monthly mortgage payments, taxes and heating expenses, and, if applicable, any association fees.
The Total Debt Service Ratio (TDSR) states that your entire monthly debt load should not exceed 40% of your gross monthly income. This debt includes your house payments, car payments and personal loans, as well as credit cards and other unsecured debts.
We have built a comprehensive Mortgage Qualification Calculator to help you figure out how much you can borrow before you talk to a lender. Simply fill in the entry fields and click on the payment schedule button to see a complete amortization schedule of your mortgage payments.
Mortgage glossary and important terms
Your gross annual income. For married couples, this is your total combined gross annual income. Please note that if you enter a purchase price or total monthly payment, the calculator will determine the gross annual income required to qualify for the purchase. This calculated amount may be higher or lower than your actual income.
The price of the home you wish to purchase. This is the actual price you pay, not including any closing costs. If you enter an annual income or a total monthly payment, the purchase price will be calculated based on these amounts.
The total monthly payment that you can qualify for. This is the total of principal, interest, taxes and heat paid each month. If you enter a purchase price or annual income, the total monthly payment will be calculated based on these amounts.
Cash needed for your down payment and closing costs. You can purchase a home with as little as 5% down payment with mortgage loan insurance. An ideal down payment is between 10 – 20% of the purchase price of the home.
The current interest rate on your mortgage.
The number of years over which you’ll repay this mortgage.
Mortgage insurance makes it possible for home buyers to purchase a home using a lower down payment. The Canadian Bank Act prohibits most federally regulated lending institutions from providing mortgages without mortgage loan insurance for amounts that exceed 80% of the value of the home, or purchases with less than 20% down payment.
The Canadian Mortgage and Housing Corporation (CMHC) and Genworth Financial are two companies that offer Mortgage Loan Insurance. For more information please visit their websites – www.chmc.ca and www.genworth.ca.