Mortgage rates are a hot topic for everyone these days – even if they’re not looking for a home loan. Will rates go up? Will they go down? What will happen to the housing marketing in Canada? But, have you ever wondered how the interest rates on your home loan are decided? Well, it’s kind of like a dance led by the Bank of Canada (BoC).

In Canada, the BoC sets the stage for interest rates. Think of it as a guide that banks and lenders follow when deciding how much to charge for loans and mortgages. And that guide is called the BoC policy rate also known as the prime rate which affects all sorts of loans you might need in life.

When it comes to your mortgage, there are two main types of mortgages: fixed-rate and variable-rate. The interest rates on these mortgages are always a bit higher than the BoC prime rate. Why? Because banks and lenders are like businesses—they want to make money when they lend to you.

Mortgage terms and your amortization period also have an effect on mortgage rates. If you need to renew your mortgage, adjusting the term and amortization period could help you manage the rise in interest rates that you’ll face when you consider a new loan especially if your mortgage is up for renewal in 2024.

Understanding all of these details can really help you make better decisions, especially if you’re buying a home for the first time or are renewing your mortgage. The changes in interest rates can make a big difference in how much you pay each month. To make it a little easier for you, I’ve broken down the way these rates are figured out and have outlined the options for short and long-term mortgages. But, don’t worry, if you have questions, I’m happy to answer them while also helping you make the best decisions possible for you and your family in regard to your home loan. Let’s dive in…

How Does The Bank of Canada Influence Mortgage Rates?

The Bank of Canada has a say in how much interest you pay on your mortgage. They want to make sure prices don’t go up too fast, so they aim to keep inflation in check at a 2% increase each year. To control this, they set a special rate called the prime rate. This rate is like a guide for banks and lenders. They use it to decide how much interest to charge on loans and mortgages, especially the ones with variable rates. So, the Bank of Canada’s decisions can affect how much you pay for your home loan.

How Does The Economy Impact Our Mortgage Rates?

The economy is the main influence when it comes to mortgage rates. If inflation is rising rapidly, the economy is affected which in turn causes a reaction from the BoC.

Inflation and interest rates are like buddies. When there is high inflation, they increase the interest rates to slow things down. On the flip side, when there is low inflation, the BoC will lower the interest rates to encourage people to spend and give the economy a little boost.

So, in simple terms, the connection between inflation and interest rates is like a seesaw. When one goes up, the other goes down, and vice versa. It’s just a way of keeping things in balance in the world of money and mortgages.

Who Actually Decides Mortgage Rates?

When it comes to mortgage rates in Canada, lenders look at two main things. First, for fixed rates, they keep an eye on bond yields with similar time frames. These are trends in the interest rates for bonds that last the same amount of time as your mortgage. Since lending money for mortgages has extra risks and costs, the rates for these mortgages are a bit higher than the yields. This helps the lender cover those extra risks and costs.

For variable rates, lenders use the prime rate, which is influenced by the Bank of Canada policy rate. The prime rate is a bit higher than the Bank of Canada rate because it includes extra costs and risks linked to mortgages. This higher rate helps the lender manage those extra expenses and risks.

Behind the scenes, there are also costs and risks for lenders when giving out mortgages. These get factored into the higher interest rates they offer you. So, when you see a mortgage rate, it’s not just a number; it includes everything that goes into making sure the lender stays in business while helping you buy your home.

Factors include the length of your mortgage term, how long it will take to pay off, the current prime rate, and more. They also look at things about you, like your credit score, debt-to-income ratio, your income stability, and your past relationship with the lender. All these things can affect the rate you are offered.

How Do Interest Rates Impact The Price Of Homes?

Imagine you need a loan (a mortgage) to buy a house. When interest rates rise, the cost of borrowing money also goes up. So, your monthly payments for the mortgage increase. This higher cost can make it harder for people to afford homes.

Now, here’s a simple example: For every $100,000 you borrow for your mortgage, if interest rates go up a bit (let’s say by 0.25%), your monthly payment might go up by around $15. It might not seem like a lot, but if interest rates go up more, those monthly payments can really add up.

While interest rates are a big player in the home-buying game, there are other factors too, like how many homes are available and how many people want to buy them. The relationship between interest rates and the housing market can affect how easily people can buy homes.

How Does Amortization Affect Your Mortgage?

Mortgage amortization refers to the length of time you will be paying off a mortgage. The length of a mortgage amortization can vary depending on the specific terms of the mortgage. The most common length for a mortgage amortization schedule is 25 years but many people in Canada are switching to a 30-year amortization period.

The length of the mortgage amortization can have a significant impact on the total amount of interest paid over the life of your home loan. A longer amortization period will result in lower monthly payments but also means paying more interest over the life of the loan. On the other hand, a shorter amortization period will result in higher monthly payments, but less interest paid over the life of the loan.

Is It Better To Go With a Long Mortgage Term Or a Short One?

The mortgage term is the length of time your mortgage contract is in effect and includes everything your mortgage contract outlines, including the interest rate. Terms can range from just a few months to five years or longer. At the end of each term, you must renew your mortgage.

When deciding between a 5-year and a 2-year fixed-rate mortgage, think about what’s happening in the market now and what might happen in the future. Consider your own goals and how much risk you’re comfortable with. If experts think interest rates will keep going up, a 5-year mortgage might be a good choice. But if rates are expected to drop, a 3-year mortgage might be better.

If you plan to stay in your home for at least 5 years, a longer mortgage term makes sense. It means you won’t have to deal with renegotiating your mortgage as often. On the other hand, if you’re thinking of selling in the next few years, a shorter term could be better. If you have to end your mortgage early, the penalty is usually lower with a 2-year term because there are fewer months left on the mortgage. So, it really depends on your plans and what’s going on in the world of finance.

Will A Short-Term Mortgage Save You Money?

The answer depends on if interest rates are expected to drop a lot in the next year. If they are, you might save money by getting a short-term fixed-rate mortgage now and switching to a better rate later. To figure out if it’s a good deal over five years, compare the total cost of a 5-year fixed-rate mortgage with the total cost of a short-term one, plus the expected cost in the following years.

Let’s look at an example using my mortgage calculator. A $500,000 mortgage with a 5% down payment amortized over 25 years with a 5-year fixed rate of 4.9% will require a monthly payment of $2,880 and cost $121,267 in interest over the 5-year term.

The same mortgage with today’s best 2-year fixed rate of 6% would require a monthly payment of $3,199 and cost $76,776 in interest over the 2-year term.

Still A Bit Confused? Give Me A Call!

A mortgage loan is probably the biggest loan you’ll ever have so understanding all the ins and outs is important. Are you thinking about buying your first home? Or is your mortgage contract up for renewal this year? Whether you’re considering a long or short-term mortgage, fixed or variable rate, I can answer all your questions and help you find the best mortgage for you. As a professional mortgage broker, I have many options that you may not have considered when you started looking for a home loan.

Schedule a virtual consultation with me today by clicking this link or give me a call directly at 705-315-0516. We can talk through your personal mortgage situation and find you the best mortgage options and rates possible in today’s market.