So for example, with $600,000 in principal at 3% interest and monthly mortgage payments over 25 years, you would end up paying over $250,000 in interest alone, with a final paid amount of around $850,000.
The same calculation, with a 2.5% interest rate would save you almost $45,000, which shows how much even a half percentage can affect how much you pay.
Your mortgage rate also determines your loan serviceability. So while homes were cheaper in the past, mortgage rates were historically much higher, therefore, the actual costs of monthly payments have not grown at the same pace as home prices.
How mortgage rates are date
There are a few things that go into determining what interest rate you are actually offered by your lender.
Fixed vs. variable interest rates
For one, the type of mortgage you take will affect your rates. Fixed mortgages are the most popular type and they hold the same fixed interest rate for the course of their loan term which is usually anywhere from 1-10 years. Since the cost of lending can change all the time, banks take on more risk by locking in a fixed interest rate for a longer period or locking it in at all. Therefore, fixed interest rates tend to be higher, with the highest rates being given to longer terms.
Variable-rate mortgages tend to have lower rates since they can change all the time, but this will not always be the case. However, since your bank is able to regularly change your rate to reflect the cost of lending, they can offer rates that more reflect the current market and do not need to account for as much for future changes.
It’s worth noting, however, that variable rates don’t always compound semi-annually like fixed-rate mortgages, so the rates aren’t as directly comparable. It also means that you can not truly calculate the total interest paid on a variable mortgage from the start as you do not know how rates will change over time.
Credit score and more
Your credit score can also affect your mortgage rate, as mortgage lenders are less likely to give you the best rate if you are a riskier lender based on your credit history. Generally, borrowers with a credit score above 680 will get the best rates while a borrower with a low credit score will receive a higher mortgage interest rate.
Other things that can affect your rate are your down payment amount, the property type being purchased, and your amortization period.
Why do mortgage rates change?
What you may not know about banks is that they do not simply hold all their money in a big vault and often have a lot of their money in circulation. Your bank may, at times, even be required to borrow money, either from the Central Bank of Canada or from other banks. In the course of these transactions, they also pay interest like you do. Therefore, just as it costs you money to borrow from a bank, it costs the banks to lend to you. In order for them to make any money, they have to charge you a rate at least somewhat higher than their lending price. The price of lending can be affected by different factors.
The variable-rate mortgage is affected primarily by the Bank of Canada’s overnight rate, also known as the prime interest rate. This is a rate determined by the Bank of Canada to determine how much lending should cost, and in doing so, have some impact on the economy. This essentially works by positioning themselves as the most expensive to borrow from or lend to, encouraging banks to lend to one another at a target rate.
In the recent recession caused by the COVID pandemic, for example, the Bank of Canada has dropped their overnight rate to record lows in order to encourage the economy to keep working through hard times by reducing the cost of spending and borrowing money.
Fixed-rate mortgages are more closely tied to government bond yields. These bonds represent a very secure place for banks to hold money long-term as they are guaranteed to repay at least the principal amount upon maturity. Though higher bond yields mean higher returns, it also means they cost more to acquire, leading to an increase in mortgage rates.
What is a good mortgage rate?
The question of a good mortgage rate will depend on your particular circumstance. Ultimately, the best rate you can get will be the one that pays the least interest over time. A bad rate would be one that makes you pay a lot more in interest. There is not really a rate that is strictly unaffordable as mortgage lenders require home buyers to remain under a certain debt level.
The most popular lenders in the country are the big six banks, and they tend to have pretty competitive rates with one another. Currently, 5-year fixed mortgage rates (the most popular mortgage product) are at around 4.4– 4.2%. Rates for 5-year variable mortgages are currently around 2.90 – 3.20%. Interest rates are currently at very low levels and are forecasted to increase in the coming years.
Alternative mortgage lenders
Beyond the major banks, there are alternative lenders who may offer very different rates. Often, these lenders cater to buyers who could not get loans from the big banks and their rates can vary greatly between them. While some may offer lower rates than the banks, they may also have additional fees or differences in compounding that can cost you a lot more.