The average Canadian homebuyer will need to apply for financing for their home purchase. Such a route makes homeownership accessible, but some may be worried about high interest rates as part of the loan agreement. As borrowers will be making payments involving the loan principal and interest, it is useful to understand more about how interest rates work.
Why Are Interest Rates Important?
It is not enough for a borrower to be approved for a loan and pay back only the principal. Lenders take on a certain amount of risk as some individuals may default on a home loan. Interest rates are intended as an incentive for lenders. Interest rates can change over time, and a home mortgage loan can have either a fixed rate or variable rate. A loan with a variable rate can have its interest rate change over the life of the loan, while the interest rate remains the same on a fixed rate loan product.
Potential borrowers may want to shop around. A conventional lender and a private lender may offer different interest rates as part of their mortgage loan products. A borrower who takes out a loan that is only a point or two lower can find that they can save thousands when it comes to paying back their mortgage loan. Homebuyers should consider how to qualify for the best mortgage rates possible.
How Are Interest Rates Displayed?
A borrower will see the annual percentage rate (APR) shown on any loan agreement in Canada. This indicates the percentage of interest expected to be paid on a loan over the period of a year. A 5 per cent interest rate (APR) on a $100,000 loan will result in paying 5000$ of interest rate for the year. One formula used for determining yearly interest rate is to multiply the monthly interest rate by 12 months. Interest rates are often calculated on an annual basis but can be calculated daily or monthly.
How Do Lenders Determine Mortgage Interest Rate?
A borrower will have some control over factors used to determine the interest rate of a loan. An excellent credit score will allow a borrower to choose from different mortgage loan products with a lower interest rate. A poor credit score generally indicates greater risk for a lender and when such borrowers are approved, they may see a higher interest rate offered as part of their mortgage loan. Credit score and financial history are the main parts of the risk premium lenders are reviewing when making their decision.
Another aspect to consider is the market premium rate. A borrower has little say in this area as it is dependent upon market position. With a variable interest rate on a loan, the changing market premium rate can lead to fluctuations in monthly payments. Interest rates in Canada are generally seen as stable, but a borrower does want to be aware of the potential for change in a variable interest rate loan.
Is It Better to Take Out a Closed Mortgage Loan?
In Canada, borrowers can take out an open or closed home loan. Closed mortgage loans are those that need to run for the full term. If a homeowner wants to pay the loan off early, they will pay additional interest, but there are exceptions. Closed mortgages can look attractive because of their cheaper interest rates. Canada's main high street lenders, RBC, TD Bank, Scotiabank and CIBC, offer closed mortgage loans with rates that vary with the time period of the loan.
Borrowers choosing an open mortgage find them more flexible. Borrowers are allowed to alter them or pay them off at any time without worrying about a penalty. Those who may want to pay off their loan early or make changes at a later date may want to investigate an open mortgage.
Is It Possible to Make Lower Mortgage Payments?
Monthly payments take into account the size of the loan and the length of time in which to repay the loan. Taking out a loan and spreading out payment over a longer period can make for lower monthly mortgage payments, but a borrower will be paying back more in interest to the lender over the life of a loan.
The amount of the loan itself will also play a role. Taking out a mortgage loan for a more affordable home can make for lower monthly payments. Borrowers may want to investigate the possibility of refinancing a home loan for better rates, but this may only be possible when sufficient equity has already been established. Speak with a lender to learn more about what is required to refinance a home loan.
Applicants wanting to buy a Leduc new home with a good credit score and financial history will qualify for different terms than those with lower credit scores. Reviewing current credit scores and financial history with a free credit report, addressing inaccuracies and paying down debt can serve to make it possible to qualify for a better mortgage loan product.
By Justin Havre