Rate options are always an interesting discussion I have regularly with my clients. I hope this article will clarify the available choices. In order for you to make an informed mortgage decision based on your goals, time horizon and risk tolerance it is important to know the difference between available payment options.
First, we will tackle the most common mortgage rate – the fixed mortgage rate. Fixed mortgage rates are based on Government of Canada (GOC) bond yields. If the GOC bond yields begin trading higher for the relative security of a national government bond, mortgage rates will increase. For a full explanation regarding this process, please see previous article I’ve written on my blog entitled “How Mortgage Rates are Set in Canada“. Your fixed mortgage rate will be based on the term you choose to lock in. If you choose a 5 year term, your mortgage payment will not fluctuate or change during that 5 year term regardless if rates go up or down in the open market. This is an attractive option for homeowners with a low risk tolerance level. It is impossible to predict if rates will go up or down (the best analysts and economists get it wrong) so the fixed mortgage gives homeowners the security of fixed payments and the ability to budget for the long term.
Variable rate Mortgages, Adjustable rate mortgages and sometimes called Floating Rate mortgages offer those with a higher risk tolerance the ability to “gamble” on the rate market. If prime rates goes down, your interest rate decreases. These rates are typically the lowest rates available and are expressed as a percentage of “Prime rate plus or Prime rate minus”. The mortgagor enjoys a current lower initial rate in exchange for the potential future interest rate risk. Each individual financial institution is responsible for setting their own prime rate and they may also change their prime rate at any time. Typically, due to competition between institutions, one will not raise or lower their prime rate unless there is a move in the Bank of Canada target overnight rate.
Although Adjustable rate, Variable Rate and Floating Rate essentially mean the same thing, each lending institution offers features that are unique to their ARM or VRM product. Some features that you should look for and inquire about are:
- Ability to lock in to a fixed rate
- Open or Closed mortgage (both are available options and is reflected in the rate)
- Prepayment privileges & Prepayment penalties with a closed VRM/ARM
- When will your payment be adjusted in relation to prime rate changes- immediately or on a prearranged schedule
- Is there a cap on the interest rate or payment
There are many hybrids of fluctuating rate mortgages on the market offering a mix of features and benefits. The most important question you must ask yourself is “Will my income be enough to cover any increase in my monthly payment obligation?”. Your mortgage professional will be able to provide detailed scenarios of what your payment will look like should an increase in prime rate occur. It is vitally important to discuss your personal goals and finances with your mortgage professional in order for them to advise what your best mortgage product looks like.
If you have any questions or comments regarding this article or your financial situation, please do not hesitate to call me at 204-260-6060.
Source: Mortgage Broker Trena Taylor