Buying a house is one of the most significant investments you'll make in your life. Unless you're among the fortunate few who can afford to pay for the property in full, you'll likely need to secure a mortgage to finance most of the purchase price.
Regardless of the type of mortgage you choose, you will need to deal with a mortgage rate. This rate, set by the financial institution you choose, may be either fixed or variable.
In any case, the mortgage rate plays a crucial role in determining the total interest you'll repay over the life of the loan. Therefore, it's important to understand the factors that influence this rate and what might cause it to change.
Remember that every business, including your financial institution, aims to make a profit. The interest rate you are charged must be higher than the cost that the institution incurs to finance your loan to ensure profitability.
While financing costs are a major factor influencing your mortgage rate, they are not the only consideration. Other factors include the lender’s operating expenses, the need to cover the risk of non-repayment, and the overall national economic condition.
Additionally, several other factors can also impact your mortgage rate. Let’s explore them.
1. Your credit history
Your credit report and payment history are crucial in determining your mortgage interest rate. This is why banks often reject mortgage applications from individuals with poor credit histories.
Lenders are primarily concerned with the risk of non-repayment. To evaluate this risk, financial institutions review your credit history, including your credit score, management of existing loans and repayments, and your track record of making payments on time.
A strong credit report indicates that you are a reliable borrower, which can reduce the lender’s concerns about repayment risk and often leads to a more favourable interest rate. On the other hand, a poor credit history usually results in a higher mortgage rate due to the increased perceived risk.
2. The characteristics of your mortgage loan
Various aspects of your mortgage loan can impact the level of risk for the financial institution, which in turn can affect your interest rate.
Mortgage insurance
If you borrow more than 80% of the property's value, you will need to obtain mortgage loan insurance. This insurance protects the lender if you default on the loan. With added protection, the lender is exposed to less risk, which often allows them to offer you a lower interest rate compared to a loan without mortgage insurance.
Mortgage term
At the end of your mortgage term, you will need to either renew your mortgage with your current lender or apply for a new one with a different financial institution. In Quebec, most mortgage contracts have a five-year term, but terms can range from six months to ten years.
As mortgage rates fluctuate, frequently renewing your mortgage increases the chances of encountering different rates, which could be either higher or lower. Opting for a longer mortgage term can help lock in a stable rate for a more extended period.
It’s worth noting that short-term mortgages usually come with lower interest rates compared to long-term ones. This is because shorter terms allow lenders to better predict market conditions, such as inflation and economic growth.
Open loan and early repayment
Repaying your loan early means the lender might receive less interest than initially expected, which can reduce their profit. To compensate for this potential loss, open mortgages, allowing early repayment without penalties, usually have higher interest rates. On the other hand, closed mortgages, which limit the amount you can repay early, typically offer lower interest rates.
3. The Canadian and global financial situation
Contrary to common belief, banks do not use their own funds to lend; instead, they borrow money from Canadian and international investors. As a result, the financing costs for lenders are closely tied to interest rates in various countries, which fluctuate for multiple reasons.
For example, during periods of economic growth, interest rates generally rise because increased demand for investment drives up rates. To attract investors, lending institutions must offer higher interest rates. Conversely, during times of low economic growth, interest rates typically fall to encourage borrowing and stimulate the economy.
Since many Canadian banks obtain funds from global markets, Canadian and Quebec interest rates are closely linked to international financial conditions. Therefore, when global rates decrease, Canadian mortgage rates are likely to follow suit.
4. The Bank of Canada's key interest rate
The Bank of Canada, the nation’s central bank, does not offer banking services to the public and is not considered a traditional financial institution. Its primary functions include managing the country's monetary policy, overseeing the financial system, and issuing banknotes. Lenders use the Bank of Canada’s key interest rate as a reference for setting their own prime rates.
When the economy is performing well, the Bank of Canada may raise the key interest rate to prevent inflation from exceeding its target. Conversely, during economic slowdowns, it may lower the rate to prevent inflation from dropping too low, as seen in 2020 to counteract the economic effects of the pandemic.
Adjustments in the key interest rate mainly have an impact on open- and short-term loans. However, these adjustments can also affect long-term rates, especially when combined with other factors such as bond prices, deposit costs, and competition within financial markets.
Researching and negotiating your mortgage rate with a broker
Interest rates can vary widely between lenders, so it's important to compare options to find the lowest rate. You have the flexibility to select your financial institution and negotiate with different banks to secure the best mortgage rate.
If you prefer not to manage this process on your own, consider using the services of a mortgage broker. A mortgage broker can investigate multiple financial institutions on your behalf, using their industry expertise and negotiation skills to help you find a favourable rate. This professional assistance can simplify the process and potentially make you save money!
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