Finding the best interest rates for your home
One of the important decisions that you will make when you negotiate a mortgage on your home is whether to opt for a fixed or variable interest rate. There are advantages to both. Around 66% of all mortgages concluded in Canada are fixed-rate mortgages. Fixed rates are particularly popular among younger people just starting out. This is because a fixed term mortgage offers a level of certainty that variable rate mortgages cannot.
With a fixed term mortgage, the rate of interest and the repayments remain unchanged over the term of the mortgage. This makes it easier for people to budget. It carries no risk since fluctuations in the interest rate are not an issue.
The difference between fixed and variable rates
In the end, your income and lifestyle, as well as your tolerance for risk, will be the determining factors in whether you choose to go with fixed or variable interest rates. Your view on the likely direction that interest rates will take in the medium to short term may also influence your decision. If you believe that the rates are likely to drop you maybe better off choosing a variable rate. If, on the other hand, you expect the interest rates to rise a fixed rate is your best call.
If you are in the financial position to tolerate interest rate fluctuations you should consider a variable interest rate mortgage. Over the longer term, regardless of fluctuations in the rate, statistics show that variable rates will cost less.
The difference between fixed and variable rates is called the spread and represents the amount that you pay to insure against interest rate fluctuations over the term of the mortgage. The spread has an influence on how many people will opt for the fixed over variable rate.
Variable interest rates
Related to Prime interest
It is the Prime interest rate that drives changes in the variable interest rate. Prime is determined by the Central Bank of Canada. The Central Bank controls the overnight rate, which is the rate at which it lends money to other banks. This is why it affects the prime interest rate. The Central Bank adjusts the overnight rate in accordance with economic factors such as inflation and unemployment.
Variable rates are quoted at a prime plus a premium or less a discount. What you end up paying will depend on your risk profile, your ability to negotiate, and the competitive environment in the market.
The repayment amount on a variable rate mortgage usually stays fixed for a period of time as determined by your contract. Instead of the payments changing the amount paid on the principal is adjusted. This means that when interest rates rise, the amount paid against the principal will drop and the amortization period will rise.
If you have the financial capacity to absorb increases in the interest rates over the term of your mortgage then a variable rate is the best option for you.
Fixed term mortgages
If you choose to go with a fixed rate mortgage your rates and repayments are locked in for the term that you select. Fixed rates are available for various terms. The length of the term that you choose may be determined by the length of time that you intend to remain in the home that you are purchasing. It may also reflect your views on the direction that interest rates will take over time.
In Canada, the average fixed term mortgage is five years. Usually the longer the term the higher the interest rate that you will pay, reflecting the higher risk of interest rate fluctuations over the period.
Fixed mortgage rates are connected to yields on government bonds of similar length. Most fixed-term mortgages carry early exit penalties that will be calculated at the greater of three months interest or the interest rate differential. In this way, the lender is compensated for the loss of interest.
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Which interest rates
should you choose?
there are a number of financial aspects that you must consider
If you take the variable rate option the best strategy to ensure that you can cope with increases in interest is to pay the amount that you would have had to pay if you had opted for the fixed term mortgage. In this way, you can reduce the principal so that if interest rates increase you have a cushion that can keep you out of trouble.
Consult your broker
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