This summer we have seen both fixed and variable interest rates consistently at historical, rock-bottom lows and in previous blogs we have explained what impacts the rise and fall of fixed mortgage rates, but what impacts the rise and falls in variable rates is still a burning question.
Your variable interest rate on your mortgage is still very much tied to the prime rate that you see in fixed mortgages but what makes it different is that it is not a set rate from month to month. As the market changes, so will the interest rate on your mortgage – In its most basic nature, it is called a variable rate because it varies from payment to payment. But what is it that makes it change? Well, the bank or lender makes it change. We often forget that although the bank is the holder of our money, they are also a business. They charge interest as a means of making money for their business to grow and prosper no differently than the rest of us.
But what does the banks business have to do with your variable mortgage rate?
Variable interest rates tend to be lower than the prime rate you see in fixed mortgages to make it more attractive to those seeking funding. You as the mortgage holder have the opportunity to benefit by not having to pay as much interest over the term of your mortgage, while the bank also benefits by having the flexibility to raise the rates if needed as things change in the market. It also allows the banks an opportunity to drum up more business by offering lower rates when the market is stable and steady. The only issue is that variable rate mortgages are more difficult to qualify for. Lenders need to make sure that you can afford your mortgage if rates go up. So they will actually use their “bank rate” which is usually about 2% higher than the rate you’ll initially be paying. This ensures that you have enough disposable income to cover a spike in your monthly mortgage payment and not fall into default.
So what would cause your variable interest rate to go up or down?
As the prime rate is influenced by the Bank of Canada’s forecast of the market in relation to the value of a Canada bond and the number of people investing in those bonds, if there is a sudden lack of interest in buying bonds the interest rates are going to climb in order to compensate. In turn, your variable interest rate would increase in reflection of that influence. However, if the markets are steady and there is much interest in buying Canada bonds, usually the prime rate would decrease. With prime rates decreasing you would expect that you would then see a decrease in your variable rate, though more often than not you don’t see an automatic shift in rate. You might see a gradual shift over time but keeping in mind that the bank is still a business they aren’t quick to decrease their variable rate, in order to benefit from the extra funds for as long as possible.
But doesn’t the Bank of Canada set the prime rate that the banks follow?
The Bank of Canada doesn’t set the prime rate, but they do influence it as a benchmark. They can’t dictate what the prime rate must be, just as they can’t dictate a decrease in variable rate. Because of this, the variable rates though attractive to some home buyers can over time become more beneficial to the banks than to those they are lending to.
If you have any questions as to which interest rate would be most beneficial to you at this point in time, feel free to give me a call at 705-315-0516. I’m always happy to answer your questions and to take a look at your specific financials in order to help you make the choice that is best for you and your family today and in the future.