The Rate Debate.

General William Douglas 11 May

One of the first questions that potential buyers want answered is: “What is your interest rate?”

It is easy to think that this is the most important question, but there is a lot more to your mortgage contract than just the rate. And so, the rate debate continues!

The rate debate is a hot topic in the mortgage world. Not just the rate itself, but the importance of the rate versus other factors in the mortgage – such as terms and penalties. As a borrower, it can be easy to get caught up in one thing but, if you’re not paying close attention, ignoring other factors could cost you in the long run.

Before we get into these other factors, let’s talk rate. While not the only factor, it does continue to be an important decision criterion with any mortgage product. The interest rate is the percentage of interest you are paying on the principal loan; lower interest rates mean more money to the mortgage and who doesn’t want that?

VARIABLE VS. FIXED

There are two types of mortgage rates: variable-rate and fixed-rate. A fixed rate is just that – a fixed amount of interest that you would pay for the term of the mortgage. A variable rate, on the other hand, is based on the current Prime Rate and can fluctuate depending on the markets.

Fixed rates are typically tied to the world economy whereas the variable rate is linked to the Canadian economy. When the economy is stable, variable rates will remain low to stimulate buying.

Fixed-Rate Mortgage: First-time homebuyers and experienced homebuyers typically love the stability of a fixed rate when just entering the mortgage space. The pros of this type of mortgage are that your payments don’t change throughout the life of the term. However, should the Prime Rate drop, you won’t be able to take advantage of potential interest savings.

Variable-Rate Mortgage: As mentioned, variable-rate mortgages are based on the Prime Rate in Canada. This means that the amount of interest you pay on your mortgage could go up or down, depending on the Prime. When considering a variable-rate mortgage, some individuals will set standard payments (based on the same mortgage at a fixed rate), this means that should Prime drop and interest rates lower, they are paying more to the principal as opposed to paying interest. If the rates go up, they simply pay more interest instead of direct to the principal loan. Other variable-rate mortgage holders will simply allow their payments to drop with Prime Rate decreases, or increase should the rate go up. Depending on your income and financial stability, this could be a great option to take advantage of market fluctuations.

BEYOND RATES

When considering your mortgage, other considerations such as penalties can be important factors for deciding on a mortgage product. If you have two competing products, say a 1.65% interest fixed rate and a 1.95% interest variable rate, it seems as though it is a pretty easy decision. But, what about the ability to make extra payments? And what are the penalties?

It is easy to think that nothing will change throughout your 5-year mortgage term, so you probably haven’t even considered the penalties. However, when looking at the fixed versus variable rate mortgage, penalties can be quite different. Where variable rates typically charge three-month interest, a fixed-rate mortgage uses an Interest Rate Differential (IRD) calculation.

Given that nearly 70% of fixed mortgages are broken before the term ends, this is an important variable. Fixed-rate mortgages are typically okay when the penalty is your contract rate versus the Benchmark rate. However, when penalties are based on the Benchmark rate (sometimes called the Bank of Canada rate), it is typically much higher than your contract rate, resulting in greater penalties.

In some cases, penalties for breaking a fixed mortgage can sometimes be two or three times higher than that of a variable rate. While the interest rate is lower, lower penalties are sometimes best should anything happen down the line.

CONVENTIONAL VS. HIGH-RATIO MORTGAGE

Another consideration beyond just the interest rate is whether or not you will be obtaining a conventional or a high-ratio mortgage. Whenever possible, it is recommended to put 20 percent down payment on a new home. This results in a conventional mortgage. However, as not everyone is able to do this, many buyers will end up with a high-ratio mortgage product.

So, what does this mean?

High-ratio mortgages need to be insured by either Genworth Financial, the Canada Mortgage and Housing Corporation (CMHC), or Canada Guaranty. This is due to the Bank Act, which will only allow financial institutions to lend up to 80 percent of the homes purchase price WITHOUT mortgage default insurance. Insurance on the mortgage is important to protect the lender should you default on your payments, leaving the insurer to deal with the borrower.

The difference between conventional and high-ratio mortgages is that high-ratio mortgages require insurance, which results in an insurance premium. This is added to and paid along with the mortgage, but is an important factor when considering your monthly payments. These premiums are based on the loan to value (LTV), which is the amount of the loan versus the value of your home.

All high-ratio mortgages are regulated to have mortgage insurance, but some homeowners with a conventional mortgage may choose to pay for mortgage insurance to get a better rate.

SMART QUESTIONS TO ASK

To ensure you understand your mortgage contract, and how it could affect you now and in the future, we have compiled a few smart questions to ask before you sign.

  1. What is my interest rate? Can I qualify for a better one?
  2. Do you recommend fixed or variable-rate?
  3. What are the penalties for breaking my mortgage?
  4. Are there any pre-payment penalties?
  5. Will I require mortgage insurance? If so, what are the premiums?
  6. What will my monthly payment be?
  7. Is my mortgage portable?

These are just a few examples of good questions to ask. It is important to do your own research and be diligent with any contract you are signing. Contacting a Dominion Lending Centres mortgage broker today can help ensure you understand what you are agreeing to, and that you are getting the best mortgage product for you!

Understanding Your Mortgage Rate.

General William Douglas 2 May

When it comes to mortgages, one of the most important influencers is interest rate but do you know how this rate is determined? It might surprise you to find out that there are 10 major factors that affect the interest you will pay on your home loan!

Knowing these factors will not only prepare you for the mortgage process, but will also help you to better understand the mortgage rates available to you.

credit score

Not surprisingly, your credit score is one of the most influential factors when it comes to your interest rate. In fact, your credit score determines if you are able to qualify for financing at all – as well as how much. In order to qualify, a minimum credit score of 680 is required for at least one borrower. Having higher credit will further showcase that you are a reliable borrower and may lead to better rates.

loan-to-value (ltv) ratio

This ratio refers to the value of the amount being borrowed as a percentage of the overall home value. The main factors that impact LTV ratios include the sales price, appraised value of the property and the amount of the down payment. Putting down more on a home, especially one with a lower purchase price, will result in a lower LTV and be more appealing to lenders. As an example, if you were to buy a home appraised at $500,000 and are able to make a down payment of $100,000 (20%), then you would be borrowing $400,000. For this transaction, the LTV is 80%.

insured vs. uninsured

Depending on how much you are able to save for a down payment, you will either have an insured or uninsured mortgage. Typically, if you put less than 20% down, you will require insurance on the property. Depending on the insurer, this can affect your borrowing power as well as the interest rates.

fixed vs. variable rate

The type of rate you are looking for will also affect how much interest you will pay. While there are benefits to both fixed and variable mortgages, it is more important to understand how they affect interest rates.  Fixed rates are based on the bond market, which depends on the amount that global investors demand to be paid for long-term lending. Variable rates, on the other hand, are based on the Bank of Canada’s overnight lending rate. This ties variable rates directly to the economic state at-home, versus fixed which are influenced on a global scale.

location

Location, location, location! This is not just true for where you want to LIVE, but it also can affect how much interest you will pay. Homes located in provinces with more competitive housing markets will typically see lower interest rates, simply due to supply and demand. On the other hand, with less movement and competition will most likely have higher rates.

rate hold

A rate hold is a guarantee offered by a lender to ‘hold’ the interest rate you were offered for up to 120 days (depending on the lender). The purpose of a rate hold is to protect you from any rate increases while you are house-hunting. It also gives you the opportunity to take advantage of any decreases to your benefit. This means that, if you were pre-approved for your mortgage and worked with a mortgage broker to obtain a ‘rate hold’, you may receive a different interest rate than someone just entering the market.

refinancing

The act of refinancing your mortgage basically means that you are restructuring your current mortgage (typically when the term is up). Whether you are changing from fixed to variable, refinancing to consolidate debt, or just seeking access to built up equity, any change to your mortgage can affect the interest rate you are offered. It is always best to discuss your options with a mortgage broker to ensure you are making the best choice for your unique situation.

home type

Among other things, lenders assess the risk associated with your home type. Some properties are viewed as higher risk than others. If the subject property is considered higher risk, the lender may require higher rates.

secondary property (income property/vacation home)

Any secondary properties or those bought for the purpose of being an income property or vacation home, will be assessed as such. The lender may deem these as high risk investments, and you may be required to pay higher interest rates than you would on a principal residence. This is another area where a mortgage broker can help. Since they have access to a variety of lenders and various rates, they can help you find the best option.

income level

The final factor is income level. While this does not have a direct affect on the interest rate you are able to obtain, it does dictate your purchasing power as well as how much you are able to put down on a home.

It is important to understand that obtaining financing for a mortgage is a complex process that looks at many factors to ensure the lender is not putting themselves at risk of default. To ensure that you – the borrower – is getting the best mortgage product for your needs, don’t hesitate to reach out to a DLC Mortgage Broker today! Mortgage brokers are licensed professionals that live and breathe mortgages, and who have access to a variety of lenders to ensure you are getting the best rates. Mortgage brokers can also assess your unique situation and find the right mortgage for you. Their goal is to see you successfully find and afford the home of your dreams and set you up for future success!