Understanding Mortgage Rates: Fixed Rate vs. Variable Rate

Fixed vs. Variable Rates: How Are They Influenced?

The Fixed Rate

Fixed rates are determined based on the bond market. When banks lend money to borrowers at a fixed rate, they typically finance themselves through the long-term bond market. This means that when the yield on Canadian government bonds rises or falls, fixed mortgage rates may follow that trend. However, they are not directly affected by the Bank of Canada’s decisions.

Example: If bond yields rise because investors anticipate higher inflation, fixed mortgage rates may also increase.

The Variable Rate

Conversely, variable rates are directly influenced by the Bank of Canada’s prime rate. When the Bank of Canada adjusts its prime rate, it immediately affects variable rates, as these loans are tied to short-term interest rates. Therefore, a decrease or increase in the prime rate will have a direct impact on the monthly payments of a borrower with a variable rate.

Example: If the Bank of Canada lowers the prime rate by 0.25%, your variable rate could decrease by the same amount, reducing your monthly payments.

Why do insured mortgages have lower rates compared to conventional mortgages?

Another common question many borrowers ask is why insured mortgages often have lower rates than conventional mortgages. The answer lies in how these loans are structured and the level of risk associated with them for lenders.

The Insured Mortgage

Insured mortgages (often for those with a down payment of less than 20%) are covered by mortgage insurance, typically through CMHC (Canada Mortgage and Housing Corporation) or other private insurers. This insurance protects the lender in the event the borrower defaults on the loan. Since the risk of non-payment is lower for the lender, financial institutions can offer a lower interest rate on these types of loans.

Additionally, for an insured mortgage, financial institutions are not required to hold as much liquidity in reserve, as the insurance provides coverage in case the borrower defaults. This lowers the overall cost of the loan for the lender, resulting in more competitive rates for the borrower.

The Conventional Mortgage

Conversely, a conventional mortgage, with a down payment of 20% or more, does not require mortgage insurance. This means the risk for the lender is higher in case the borrower defaults, and the bank must also hold more liquidity to cover this risk. These factors explain why interest rates for conventional mortgages are generally slightly higher.

Conclusion

The world of mortgages can seem complex, but with a good understanding of the factors that influence rates and the different types of loans, you can make an informed choice that suits your financial needs. As a mortgage broker, I’m here to guide you every step of the way and help you find the best solution for your situation.

Do you have questions or want to learn more? Contact me for a free consultation!