The Bank of Canada raised short-term interest rates this week, and more increases are expected later in the year, prompting many home buyers and mortgage holders to ask whether a variable-rate mortgage or a fixed-rate mortgage is best for them.
How, exactly, are mortgage rates offered by lenders determined? Many Canadian mortgage holders are surprised to learn that the pricing for variable-rate and fixed-rate mortgages are determined by two different means.
First, let’s look at the pricing of variable-rate or “floating rate” mortgages. The rate for these mortgages is tied directly to the prime rate, which is set by the Bank of Canada, usually through regularly scheduled announcements. Very competitive variable rate mortgages are now commonly available.
“Those with variable rate mortgages need to keep an eye on the prime rate,” says Margaret Dron, a mortgage broker with Invis, “and should keep in contact with a mortgage professional, who can explain interest rate trends.”
Pricing for fixed-rate mortgages follows a separate dynamic and is a bit more complex. Fixed-rate mortgages are priced in relation to the bond markets, as bonds are the main competing investment to mortgages for investors. Mortgages are priced higher than bonds, usually between about 1.2 per cent and 1.9 per cent, to account for higher risk of default and administration costs incurred by investors who hold mortgages as opposed to relatively hassle-free bonds.
The most popular type of mortgage in Canada is currently the five year fixed-rate mortgage. Discounted rates for this type of mortgage (available through a mortgage broker) have been trending upwards in recent weeks.
“With rates for both variable and fixed mortgages relatively low, consumers must decide based on their own preferences and unique circumstances,” says Dron, “A mortgage broker can help consumers evaluate their mortgage options and make an optimal choice.”
Jun 2, 2010
Article by Margaret Dron
