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Let's talk about Interest Rates

What is interest?

Interest is the fee you pay your lender for the use of their money.

When you apply for a mortgage, your lender may offer different interest rate options. The interest rate is used to calculate how much you need to pay to borrow money. These rates rise and fall over time.

Every time you renew your mortgage term, you renegotiate your mortgage interest rate. This means your mortgage payments could be higher or lower in the future.

How your lender sets your interest rate

Lenders set the interest rate for your mortgage. They consider factors to help them determine your cost.

These factors can include:

  • The length of your mortgage term

  • Their current prime and posted interest rate

  • If you qualify for a discounted interest rate

  • The type of interest you choose (fixed, variable or a combination)

  • Your credit history

  • If you’re self-employed

Lenders typically offer higher interest rates when the term length is longer. It’s not always the case.

Prime interest rates

The prime interest rate is the rate lenders use to set their posted interest rate. The rates can change regularly.

Your lender may offer you an interest rate of prime plus a percent. This is often the case with a variable rate mortgage.

For example, your lender can offer you a rate of prime plus 1%. This means your interest rate is 1% higher than the listed prime amount. If the prime rate is 3.5%, your rate is 4.5% or 3.5% + 1%. If the prime rate increases to 3.7%, your rate increases to 4.7% or 3.7% + 1%.

Posted interest rates

The posted interest rate is the rate lenders advertise for their products. For example, these are the rate you see on your lender’s website. These rates can change regularly.

Discounted rates

A discounted rate is lower than the lender’s posted rates. Ask your lender if they can offer you a discounted rate. This could save you thousands of dollars.

How much interest can cost

Your interest rate and how it’s calculated affects your regular mortgage payments. A mortgage is usually a large amount of money. Therefore, small differences in the interest rate can have a significant impact on your costs.

Make sure your home is within your budget. Consider if you’re comfortable with the possibility of interest rates increasing. Determine if your budget could handle higher payments. If not, you may be overextending yourself.

How your credit rating affects your interest rate

Lenders look at your credit report and credit score to decide if they will lend you money. They also use them to determine how much interest they will charge you to borrow money.

If you have no credit history or a poor credit history, it could be harder for you to get a mortgage. If you have good credit history, you may be able to get a lower interest rate on your mortgage. This can save you a lot of money over time.

Fixed interest rate mortgage

Fixed interest rates stay the same for your entire term. They are usually higher than variable interest rates.

A fixed interest rate mortgage may be better for you if you want to:

  • Keep your payments the same over the term of your mortgage

  • Know in advance how much principal you’ll pay by the end of your term

  • Keep your interest rate the same because you think market interest rates will go up

Variable interest rate mortgage

A variable interest rate can increase and decrease during your term. If you choose a variable interest rate, your rate may be lower than if you selected a fixed rate.

The rise and fall of interest rates are difficult to predict. Consider how much of an increase in mortgage payments you’d be able to afford if interest rates rise. Note that between 2005 and 2015, interest rates varied from 0.5% to 4.75%.

Consider if you’re comfortable with the possibility of interest rates increasing. Determine if your budget could handle higher payments. If not, a fixed interest rate mortgage may be better for you. You may also consider fixed payments with a variable interest rate.

A variable interest rate mortgage may be better for you if you’re comfortable with:

  • Your interest rate changing

  • Your mortgage payments potentially changing

  • The need to follow interest rates closely if your mortgage has a convertibility option

Fixed payments with a variable interest rate

If the interest rate goes up, more of your payment goes towards the interest, and less to the principal.

If the interest rate goes down, more of your payment goes towards to the principal. This means, you pay off your mortgage faster.

If the market interest rates increase to a certain percentage or trigger point, your lender may increase your payments. This payment increase will make sure that you pay off your mortgage by the end of the amortization period. The trigger point is listed in your mortgage contract.

Adjustable payments with a variable interest rate

With adjustable payments, the amount of your payment changes if the interest rate changes. A set amount of each payment applies to the principal. The interest portion changes as the interest rates change. You’ll know in advance how much of the principal you’ll have paid at the end of the term.

What you can do to protect yourself if interest rates rise

If the interest rate rises, your payments increase. Make sure that you can adjust your budget in case your payments increase.

Ask your lender if they offer:

  • An interest rate cap: a maximum interest rate your lender can charge on a mortgage. You never have to pay more in interest than the maximum cap, even if the interest rates rise

  • A convertibility feature: where, at any time during your term, you can convert or change your mortgage to a fixed interest rate

Note that if you choose a convertibility feature and change your mortgage to a fixed interest rate:

  • You usually have to pay a fee

  • Certain conditions may apply

  • Your new fixed interest rate may be higher than the variable interest rate you've been paying

Hybrid or combination mortgages

You could choose to opt for a hybrid or combination mortgage. In these mortgages, part of your interest rate is fixed and the other is variable.

The fixed portion gives you partial protection in case interest rates go up. The variable portion provides partial benefits if rates fall.

Each portion may have different terms. This means hybrid mortgages may be harder to transfer to another lender.

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