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A Guide to Help You Understand Mortgage Rates
Are you applying for your first mortgage? Interest will take up a chunk of every mortgage payment, so now is the time to find out how mortgage rates work and how to make sure yours works for you. Of course, you already know at least one thing about mortgage interest rates: you want the lowest possible number. But which numbers are realistic for you, and how do you maximize your chances of minimizing your interest costs?
Before you take the next step and consider different loan offers, look behind the scenes to learn how lenders determine mortgage rates, distinguish between different mortgage types, and more. Here’s what you need to know about mortgage interest rates.
What Are Mortgage Rates? What Influences Them?
Every time you make a mortgage payment, your money goes toward two different components: your principal loan (how much you borrowed to buy your house) and your interest costs.
The lowest interest rates are available to buyers with good credit, but interest rates may soar because of anything from an undesirable neighbourhood to a spotty credit report. That’s why it’s so important to understand and anticipate how lenders will calculate yours.
Who Sets Mortgage Rates?
Mortgage lenders, including banks and credit unions, determine a specific mortgage interest rate for each borrower. This rate depends on many different factors, from local and federal trends to your specific credit score, income, and property.
How Banks Calculate What You Can Afford
Interest rates reflect the amount of risk your lender is willing to accept. The more confident they are in your financial stability, the lower your rate will be. Of course, that means they must consider a wide variety of figures and factors, from your current finances to the greater economic picture. So, how do banks know how much to charge?
If you want to know how to calculate mortgage interest, follow the lead of all lenders, and start by figuring out these ratios:
- Gross Debt Service: Your GDS ratio represents all your monthly housing costs, divided by your total monthly income. The GDS ratio includes mortgage payments, heat, property taxes, and 50% of condo fees. What percent of your income will you need to cover these costs? In many cases, lenders will accept a GDS of 39 percent or lower.
- Total Debt Service: Your TDS ratio tells lenders how much money goes toward your GDS and all of your other debts. Divide the total of your monthly loan payments (including student loans, credit card payments, and more) by your total monthly income. Is the figure 42 percent or lower?
NOTE: Even if you’re going to do the math on your own, make sure you run your numbers past a mortgage broker to make sure you’re getting your calculations right. For example, when determining your GDS ratio, heating costs will vary depending on a home’s square footage.
There are plenty of other details and wrinkles to watch for, too. For instance, if you have a balance on a line of credit or credit card, your lenders won’t use the minimum payment to determine if you qualify, but 3% of the balance month to month. Talking with a broker can help ensure you catch all these details—even if you’re a math whiz.
If your GDS or TDS ratios are higher than the industry ideals, it doesn’t mean your outlook is grim or impossible to change. And even if these figures are perfect on paper, local real estate trends and national economic trends also affect the maximum and minimum mortgage interest rates at any given time.
Fixed vs. Variable Rates
For starters, there are two types of mortgage rates, and the type you choose will determine whether and how it fluctuates. Do you want a fixed rate mortgage or a variable rate mortgage? Picking the wrong type is a common mortgage mistake, so make sure you understand the differences between them before you decide.
Which Mortgage is Best for You?
How do you know which type of mortgage is right? Well, a fixed rate is when you can lock your mortgage interest rate for a certain amount of time, while a variable rate will fluctuate during your contract when the Bank of Canada changes the prime rate. Is a variable rate better than a fixed rate? The data shows variable rate mortgage borrowers typically pay less over time compared to fixed rate borrowers. However, the fluctuating rate of a variable product can pose a risk. Getting a fixed mortgage interest rate will help boost your immunity to fluctuating trends.
Before you submit any offers to purchase a home, you need the backing of an official pre-approval from a mortgage lender. Getting pre-approved for a mortgage is also the only way to accurately anticipate your mortgage interest costs because your offer will include your interest rate. Of course, this rate may still change before your contract is signed.
What Happens if Interest Rates Change?
Sometimes, the Bank of Canada changes interest rates. This is always done to protect the Canadian economy and to help ensure people aren’t borrowing too much and carrying too much debt, or to keep inflation rates low.
What happens when interest rates change, though? How does that affect your mortgage?
How Interest Rate Changes Affect Fixed and Variable Mortgages
Rate fluctuations affect each type of mortgage in different ways. For example, before you sign your paperwork, the Bank of Canada’s prime rate and lender prime rates can drop or spike.
If you’ve got a fixed mortgage, you’re okay—your rate is locked in. Variable rate mortgages, however, will fluctuate if interest rates change. It might only be a small additional sum on your usual payment, but over the lifetime of your mortgage, it can add up to thousands in additional costs.
How Mortgage Brokers Help You
Instead of sticking with a single lender or trying to shop for different mortgage interest rates on your own, consider a mortgage broker who knows how to handle each step of the process. Brokers have the connections and knowledge necessary to easily handle common real estate dilemmas, such as getting a mortgage with bad credit or negotiating with lenders for a lower mortgage rate. Contact a Mortgage Broker today to get started.
Chris Allard’s experience in the field means he can get you offers with over 50 financial institutions lending in Ottawa. Every lender has many mortgage products they offer, which means Chris and his team will make sure a mortgage caters to your needs while also ensuring you get a competitive rate. Chris Allard is a proud mortgage broker of Smart Debt Mortgages, independently owned and operated. Smart Debt broker #12236.