Equip Yourself with the Knowledge You Need About Mortgage Interest Rates
Mortgage interest rate can seem like a loaded term but once you break down what it means, you can better understand what it means for your money and homebuying power. So, let’s start with the basics. In this guide, you’ll learn what mortgage interest rates are, how they work, how they’re calculated, and how you can find the best rate for you.
What’s a Mortgage Interest Rate?
To keep it simple, your mortgage interest rate is what it costs you each month to finance your property with a lender. It’s an amount you must pay in addition to paying off the amount that you’ve borrowed to purchase a home.
Your interest rate is basically the lender’s compensation for letting you use their money to purchase your property. The good news is: your interest will be included in your monthly mortgage payment, so you won’t have to worry about a separate bill coming your way.
How Does a Mortgage Interest Rate Work?
Interest is calculated as a percentage of the mortgage amount, and the interest on your mortgage is generally calculated monthly.
Your lender will take your remaining loan balance at the end of each month and multiply it by the interest rate that applies to your loan, then divide that amount by 12. There are lots of helpful mortgage interest calculators online that you can use to estimate your interest costs before purchasing a house.
How Do You Get a Good Interest Rate?
A good interest rate is considered a low percentage rate. In the past, average mortgage interest rates currently hover around 5% to 8%, but can range from 3% to 20%. Rates, however, can vary by lender so it’s always important to shop around for the mortgage lender that’s offering the best terms for you.
So why do interest rates vary by lender and are not standard across the industry? Well, each lender has its own overhead and operating costs. This means that in order for each lender to make a profit, their charges will vary and so will your interest rate.
However, your interest rate is primarily based on your financial situation. The more money you want to borrow and the lower your credit score (which signifies the likelihood you’ll pay back the loan to a lender), and the riskier you are as a borrower, the higher your rate will be. The stronger your credit score and the less money you plan to borrow, the better your chances will be for a lower interest rate.
Here’s what lenders consider when determining your interest rate (which is why having all your documentation (link to documentation article) on-hand is so important):
- Your credit score
- Your repayment history and any collections, bankruptcies, or other financial events
- Your income and employment history
- Your level of existing debt
- Your cash reserves and assets
- The size of your down payment
- Property location of the house you’re looking to purchase
- The amount you’re looking to loan (total amount)
- The type of loan you’re considering
- The term of the loan
What’s the Difference Between a Mortgage Term and Amortization Period?
Your mortgage term is the length of time your mortgage contract is valid. In Canada, a mortgage term can run anywhere from six months to 10 years. The most popular mortgage term is a five-year fixed-rate mortgage. This term provides borrowers with a predictable payment schedule without feeling like they’re locked into a contract for an uncomfortably long period of time.
Your loan’s amortization period is the length of time it will take you to pay off your mortgage in its entirety. The most common timeframe for this in Canada is 25 years.
What’s the Difference Between a Fixed-Rate and Variable-Rate Mortgage?
This is an important question so you understand the two types of mortgage rates and how they can affect your interest rate.
A fixed-rate mortgage is the most common loan option, especially for first-time homebuyers. With this mortgage, your interest remains the same throughout the life of the mortgage. The benefit of this option is that you won’t have any unexpected interest rate increases as the market fluctuates.
There’s a chance, however, that you could be paying more for interest than the market average if mortgage interest rates decrease across the board. Still, this option provides set expectations for borrowers so they know what to expect for their payments each month.
A variable-rate mortgage is a bit riskier but can pay off in the end. Your interest rate with this option will fluctuate depending on market conditions. You’ll most likely have a fixed interest rate for a set period of time to start, but then the rate will be adjusted based on the lender’s prime rate for the remainder of the mortgage life.
With this option, your monthly mortgage payment can go up or down to account for changes in the interest rate. However, on average interest rates for this mortgage option are generally lower than interest rates on fixed-rate mortgages.
What’s the Best Way to Compare Mortgage Interest Rates?
Because lenders’ mortgage rates vary, it’s important to shop around to find the best mortgage rate for you from several vendors. This can help save quite a bit of money over the life of the loan, making it certainly worth the hassle of the additional forms. You can also work with a mortgage broker who will do the shopping for you and provide you with comparable rates.
Prioritize Your Best Interest
As you can see, there are many things to consider when talking about mortgage interest rates. That’s why understanding your options and shopping for the best rate you can find is crucial to being an informed homebuyer. Now that you’ve learned about interest, you’re ready to learn how to calculate monthly mortgage payments with Mortgage Math 101 (link to article).