How Do 2 Interest Rates Affect Your Mortgage

Jun 15, 2022

Interest Rates

Interest Rates

How Interest Rates Affect Your Mortgage

Mortgage Interest Rates have been increasing for the last couple of weeks. Making it more challenging for people to afford a mortgage, and perhaps get the rate they wanted or saw weeks prior to the changes. These changes are causing huge amounts of inflation, worldwide.

Relationship Between Inflation and Mortgage Rates

Although most inflation could damage the economy, there are some classifications that can lead to a healthy economy. When inflation rises too quickly, it can a bit out of control. Many are racing to increase their prices to keep up, but this can lead to the dollar dropping sharply. When these are left unchecked, it can cause recession.

To prevent this from happening, the Bank of Canada has a mandate to keep inflation at a target rate of 2% per year. This is to set a target for the overnight rate, which is the cost for banks to borrow money from each other, over the course of one night. When the overnight rate goes up, the banks raise their interest rates to cover their costs. When interest rates go up, people are less likely to borrow money, so they rein in their spending and become more likely to save. This, in turn, puts downward pressure on prices and slows the rate of inflation.

How Are Variable and Fixed Mortgage Rates Affected?

Variable mortgage rates are directly affected by interest rate inclines is because, they’re expressed in relationship to the bank’s prime rate. For example, the best variable mortgage rates are currently Prime – 1.45%. Due to the prime rate, which is currently 3.70%, you would pay an actual mortgage rate of 2.25%. If the Bank of Canada raises the overnight rate by 0.25%, and the bank to raise their prime rate by the same amount, banks will respond by also raising their prime rate and in turn your mortgage rate would also increase.

Fixed mortgage rates aren’t directly affected by interest rate inclines. Existing fixed-rate mortgages aren’t affected when interest rates go up or down. Rates for new fixed mortgages are still likely to go up, but they’re not tied to the bank’s prime rate. Instead, fixed mortgage rates closely follow bond yields which are pushed higher as a higher result of rising rates.

Benefits of a Fixed Rate Mortgage

When you make payments on a fixed-rate mortgage, the amount that goes towards the principal and the amount that goes towards interest rates will vary with every month-to-month payment. The following benefits is what you can expect from this type of mortgage:

  • Fixed-rate mortgages are easier to understand
  • Mortgage payment amount remains the same throughout the whole term of the mortgage
  • You have security as you know what is to be expected
  • It’s a lot easier to budget for your household costs
  • As the principal is reduced, all the interest charged, will also be reduced and more of your payment will go towards the principal

If you have a strict budget and may have some difficulty adjusting it or paying other expenses if, for any reason your mortgage rate increases, even temporarily or ever-so-slightly, this may be the best option for you. You don’t want an unexpected increase, no matter how small, to cause any undue financial hardship to you or your family.

Benefits of a Variable Rate Mortgage

While knowing how much you’ll be paying each month brings peace of mind, for some borrowers, the thought of having lower monthly payments is very appealing. The benefits for when you choose to go down this route are:

  • The variable rate is most likely going to be lower than the fixed rate
  • They tend to be less expensive over the term of the mortgage

You must keep in mind that if you choose a variable-rate mortgage, you are at the inclination of prime rate fluctuations. While you could end up saving money over the term of the mortgage, the rates could potentially increase significantly, leaving you with a much higher monthly payment.

By the same token, it’s common in Canada to obtain a mortgage term between a few months and five years. At the end of the term, you must renew your mortgage. This gives you the option of switching to a fixed-rate mortgage or taking advantage of a lower interest rate if available.

It is VERY important to have a clear understanding of the implications that may happen when it comes to choosing the best interest rates for your mortgage, and how they can affect you. It makes all the difference in future planning and can impact you in very significant ways.

At GLM Mortgage Group, our Mortgage Brokers know what questions to ask. We have relationships with the lenders that you know about and the lenders you don’t. We would be pleased to educate you on the financial options available to you. We want you to make the best decision possible on the mortgage that you are committing to. Call us anytime for a FREE consultation on the mortgage products available to you.

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