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Lenders generally offer two types of interest rates: fixed rate and variable rate. The fixed rate remains the same throughout the mortgage term, regardless of market fluctuations.

Conversely, financial institutions may adjust the variable interest rate upward or downward during the loan term. With most banks, the amount of your mortgage payments does not change, even if your mortgage has a variable rate. Only the portion of the installment allocated to repaying the principal changes. For example, if interest rates rise, the proportion of the payment used to repay interest also increases. In some cases, however, an adjustment to the mortgage payment is mandatory, particularly if the amount no longer covers the interest.

Additionally, the fixed rate is generally higher than the variable rate. To lock in the fixed rate until the end of your mortgage term, your lender charges you a premium. However, this specific point is insufficient to determine which interest rate to choose. Xperto provides further details on mortgage rates:

• A fixed rate is relevant if a significant rise in interest rates is expected in the near future. Although higher, this mortgage rate offers peace of mind, as you are not exposed to market volatility and the resulting changes in principal and interest repayment. The fixed rate allows you to know the exact cost of your mortgage.
• A variable rate is relevant if interest rates are falling, as has been the case in recent decades. Choosing a variable-rate mortgage can still be advantageous if interest rates remain stable or increase only minimally. Moreover, according to a study conducted between 1950 and 2000, in 90% of cases, loans with variable mortgage rates cost less than fixed-interest loans. However, your income must allow you to withstand a potential rise in interest rates.

A mortgage can also combine a variable interest rate and a fixed interest rate. This is referred to as a combined or hybrid mortgage. A fixed rate is applied to one portion of the mortgage, and a variable rate to the remaining portion. This system offers several advantages. The fixed portion protects you from potential interest rate hikes, while the variable portion allows you to benefit from rate decreases. However, a combined mortgage may involve additional costs, particularly for property appraisal.

The mortgage does not cover the full purchase price of a home. Financial institutions require you to pay a certain amount when purchasing the property: the down payment. This contribution is typically between 5% and 20% of the property’s purchase price.

The down payment is related to the loan-to-value ratio (LTV), an index that allows the lender to assess credit risk. The larger the down payment, the lower the LTV. With a higher personal contribution, the borrowed capital is lower, and the lender is exposed to less risk. They may then offer a more attractive variable mortgage rate or fixed rate.

However, this contribution can also affect mortgage loan rates in another way. If the down payment is less than 20%, you will need to take out mortgage loan insurance. With this guarantee, financial institutions are more inclined to offer you a lower mortgage rate. However, as Xperto explains, this situation is not always advantageous.

Mortgage loan insurance comes at a cost. The premium amount is inversely proportional to the down payment. Insurance fees can range from 2.80% to 4% of the mortgage loan amount, equivalent to several thousand dollars. Additionally, you must pay the insurance premium in one lump sum or add its cost to the principal balance of the mortgage loan.

The loan term or mortgage term refers to the period of validity of the mortgage contract. At the end of the term, you must renew the contract or refinance it if you have not yet fully repaid your mortgage loan. The mortgage loan term ranges from 6 months to 10 years. Its duration can influence the mortgage rate, as Xperto explains:

• Long-term mortgage loan

Beyond a term of 3 years, it is considered a long-term mortgage loan. The mortgage rate remains unchanged for a long period, and in return, the financial institution is compelled to apply a higher mortgage rate. However, this term has some advantages. This choice can be beneficial to protect against an upcoming increase in the mortgage rate. Conversely, you cannot take advantage of a potential decrease. A long-term mortgage loan also avoids the need for frequent renewals.

• Short-term mortgage loan

Financial institutions consider a mortgage loan short-term when the contract ranges from 6 months to 3 years. In most cases, this type of contract offers a lower mortgage rate, closely aligned with market trends. However, it involves a much higher frequency of contract renewals. A short-term mortgage loan may be more suitable if you have a new project in mind, such as moving or selling the house in the near future. But if you break your contract before its term, the financial institution will charge you mortgage penalties.

• Closed mortgage loan and open mortgage loan

The method for calculating these prepayment fees varies from lender to lender. Financial institutions may charge 3 months’ interest or apply the interest rate differential. The latter method mainly applies to fixed-rate mortgage loans. An open mortgage loan can help you avoid these penalties. It involves paying, in addition to the monthly mortgage payment, an extra amount without any fees.
However, the interest rate applied to this type of loan is often higher than for a closed-rate mortgage loan. Moreover, most borrowers choose the latter option for this reason. In fact, most applicants do not plan to repay their loan before the term. But some closed mortgage loan contracts are less strict and may allow, once a year, the repayment of a certain amount without any penalty.

The amortization period refers to the timeframe within which a borrower must fully repay their mortgage. In Canada, the standard amortization period is 25 years. However, it is entirely possible to opt for a much longer period. In such cases, financial institutions may require a minimum down payment of 20% to mitigate risks. This means you will need to renew your mortgage contract multiple times until the end of the amortization period.

The choice of amortization period should be carefully considered, as it also impacts the mortgage rate:

• A long amortization period increases the total cost of the mortgage. Even if the monthly mortgage payments are lower, the repayment is spread over a longer period, resulting in more interest paid over time.
• A short amortization period is less expensive overall, but it requires handling higher monthly mortgage payments. Since the loan repayment timeframe is shorter, you pay less interest in total.

It is more accurate to refer to it as a mortgage payment. This is the amount you must pay weekly, bi-weekly, or monthly to repay your mortgage loan. The mortgage payment covers both the principal and the interest. This amount may also include the CMHC insurance premium if your down payment is less than 20%, requiring you to purchase mortgage loan insurance.

The amount of your mortgage payments depends on several factors. Xperto highlights the main ones:

• The financed amount, which is the difference between the property’s purchase price and your down payment;
• The amortization period;
• The interest rate.

By inputting these details into a mathematical formula, you can calculate your mortgage payment amount. To simplify this process, Xperto provides an online calculator. Simply fill in the fields to get an estimate of your mortgage payment. You can also explore different scenarios by adjusting the interest rate, amortization period, or mortgage cost.

The value provided by Xperto’s calculator is purely hypothetical. In reality, financial institutions consider many other factors to determine your mortgage payment, including:

• The property’s location;
• Its purchase price;
• Your credit score;
• The type of interest rate (fixed or variable);
• The down payment amount.

Financial institutions also consider the key interest rate when setting mortgage interest rates. The key interest rate, or overnight rate target, is the interest rate at which the Central Bank encourages banks to lend money to each other for one day on the interbank market. Banks conduct numerous transactions every business day. At the end of the day, they settle accounts and process various payments. However, balances are rarely even, and to cover deficits, banks borrow from the overnight interbank lending market, which is controlled by the Bank of Canada.

Each year, the Bank of Canada announces changes to the key interest rate on eight predetermined dates. However, adjustments can also be made outside this schedule. These increases or decreases depend on the economic situation and influence mortgage interest rates. For example, if the economy is declining, as during the coronavirus pandemic, the key interest rate is lowered to encourage potential borrowers to take out loans. Conversely, to curb inflation, the Bank of Canada tends to raise the key interest rate to slow economic activity. In this way, the Bank of Canada can indirectly control inflation or stimulate the economy.

Changes in the key interest rate impact variable mortgage rates but can also affect fixed mortgage rates. The latter are heavily influenced by fluctuations in bond yields.

The prime interest rate is a specific interest rate set by each Canadian financial institution and applied to its loan products. This interest rate serves as the basis for calculating the variable interest rate and does not apply to fixed-rate mortgages. The bank may increase or decrease it based on fluctuations in market interest rates.

The amount of the premium or discount is variable and depends on the nature of the loan, as well as the borrower’s repayment capacity. Thus, if you have a creditworthy profile, your bank may apply a more significant reduction in the event of a decrease in interest rates or a smaller premium if an increase in mortgage rates occurs. Conversely, for a higher-risk individual, the discount will be smaller and the premium higher.

Although each financial institution sets its own prime interest rate, it remains dependent on the Bank of Canada’s key interest rate. If this overnight rate increases or decreases, the prime interest rate follows the trend.

Prime Interest Rate and Home Equity Line of Credit (HELOC)

A home equity line of credit (HELOC) is an option offered in certain mortgage contracts. This revolving loan is particularly useful if you need emergency funds for projects such as home renovations. You simply need to notify your financial institution of the amount you require, and they can release the funds, up to a limit of 65% of your property’s value.

However, a variable rate is applied for repaying the line of credit. As with a variable-rate mortgage, its calculation is based on the prime mortgage rate, to which a premium or discount is applied depending on market fluctuations. You will then have to pay a higher monthly payment if interest rates rise.

On the other hand, the revolving nature of the loan offers an advantage over a personal loan. With a personal loan, you are forced to borrow a larger amount to ensure you have enough money for your project. If the allocated budget ultimately exceeds the actual expenses, you still have to repay the full borrowed amount. With a home equity line of credit, you have the flexibility to re-borrow if the funds are insufficient.

Xperto summarizes the various parameters that can influence your mortgage rate:

• Your creditworthiness. A profile with a good credit score will receive a lower mortgage rate than a high-risk borrower;
• The frequency of mortgage renewal. A contract with a shorter mortgage term involves more renewals. In this case, the bank will generally apply a lower interest rate;
• The type of rate. In most cases, fixed-rate mortgages have a higher interest rate than variable-rate loans. To better protect themselves, financial institutions also tend to apply a higher interest rate for open mortgages. They indeed receive less interest if the borrower repays the loan before the end of the contract;
• Subscribing to mortgage loan insurance. An insured loan may come with a more attractive interest rate, but the premiums can increase the total cost of the credit;
• The amount of the down payment. The larger it is, the less financial institutions are exposed to risks. They are then more inclined to offer a lower interest rate.

However, banks do not only consider these parameters when setting an interest rate. Discover with Xperto other factors that impact the calculation of your mortgage rate:

• Commercial factors, or more precisely, bond yields. To generate returns, mortgage lenders charge borrowers an interest rate higher than the rate at which they borrow from investors;
• Economic factors such as the unemployment rate and production levels. If the economy slows down, there are fewer mortgage applicants, and the interest rate is lower. Conversely, if the economy is growing, financial institutions apply a higher interest rate;
• The key interest rate set by the Bank of Canada. Changes in this overnight rate target particularly affect the variable rate. Fluctuations in the prime rate indeed depend on changes in the key interest rate.

According to Statistics Canada data, the 5-year fixed-rate mortgage is the most popular among borrowers in Canada. As of May 2021, it accounted for over half of all mortgages — significantly more than all variable-rate mortgages combined. The outstanding balance for these 5-year fixed-rate mortgages reached nearly $670 billion. Given this popularity, the CMHC’s mortgage stress test is based on the Bank of Canada’s 5-year benchmark rate.

Shorter-term fixed-rate mortgages are less common. Outstanding balances were:
– $257 billion for terms of 3 to less than 5 years
– $72 billion for terms of 1 to less than 3 years
– Only $8 billion for terms of less than 1 year

The success of the 5-year fixed-rate mortgage highlights borrowers’ preference for predictability. During the 5-year term, the interest rate and payment amounts remain unchanged. However, upon renewal, the rate may adjust to market fluctuations, potentially increasing or decreasing. Despite this, the 5-year fixed rate is generally higher than variable rates for the same term. This product is widely available from most lenders.

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