Understanding interest rates

Interest rate is the cost of borrowing money. The amount of interest charged is stated as a percentage for example 3.39 %. To give a concrete example, if you apply to borrow $5000 for a year at the bank and you are awarded that loan, the bank would charge you a 4% (example) interest rate. At year’s end, you will have to repay the initial $5000 and the added interests of 200$ which would amount to a total of $5200. According to this simulation, the price you paid for the loan would have been $200. Interest rates can fluctuate dramatically over the course of a year because they are affected and adjusted by the market conditions.   

Interest rates on a longer timeline to pay back the loan, as it is guaranteed by property value.

When the time comes for you to choose your mortgage, keep in mind which interest rate type will be most beneficial to you, as well as the loan conditions.

Fixed rate will not vary during the term of your mortgage, usually 1, 2, 3 or 5 years or more. A fixed interest rate allows you to make a fixed payment each month, which is easier to plan. You will not be affected by fluctuations in interest rates.

The variable interest rate will fluctuate with the market. As it refers to the Bank of Canada's key rate, the variable rate will go up when the key rate rises and go down when the key rate decreases.This rate is decided in meetings that take place usually every six weeks and the outcome of which depends on a variety of economic factors. To obtain the date of these meetings, please click here. Historically, variable rates have benefited the borrowers but only a solid assessment of your financial situation may dictate whether a variable rate is for you. To opt for this type of rate, you must have the financial means to carry out these fluctuations. Strategies may allow you to receive a variable rate while protecting you against any rate increases. To this end, your mortgage broker can help you decide between a floating rate and fixed rate.

An intermediate solution between the fixed and the variable interest rate is the protected variable interest rate (also called capped). The interest rate you pay will fluctuate with the market, but cannot exceed a predetermined threshold. So you get the advantage of a variable interest rate, but without the disadvantage of assuming significant fluctuations in your payments. Be aware that if the market rates were to exceed the ceiling level of your predetermined payment, the amount of your payment will not immediately be transferred but would be capitalized and added to the balance of your mortgage.

In some cases, you will want to opt for an instalment interest rate. Thus, for the same mortgage, you can divide the amount in instalments which will then each have their own amortization, term and rate. This kind of product can protect you against fluctuations in interest rates. In fact, if your mortgage terms come to an end at different times, you can avoid having to renew the entire mortgage amount at a time when interest rates are high. The main disadvantage of this product is the impact it has on your negotiating skills. With several fractions that come to term at different times, if you want to shop around to change financial institutions, you may have to pay penalties for each of the fractions that have not yet come to term. Thus, the more fractions you have, the harder it becomes to renegotiate your mortgage without having to pay penalties.

Your broker will be a big help guiding you through choosing the type of rate that is best for you.


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