Purchasing a home is a significant investment that often requires a mortgage, which involves paying a substantial amount in interest over time. Understanding the factors that determine the interest rate on your mortgage is crucial, whether you’re a homeowner or not.

The interest rate on a mortgage is influenced by various factors. Lenders aim to make a profit by charging a higher interest rate than their funding cost, which includes borrowing funds, operational expenses, and covering the risk of non-repayment.

The state of the economy, both domestically and globally, plays a vital role in determining the funding cost. Strong economic growth usually leads to higher interest rates, while weak growth results in lower rates. Economic conditions impact the demand for money and affect interest rates. Additionally, Canadian banks borrow funds from other countries, and global developments influence interest rates in Canada.

The Bank of Canada also influences interest rates through its policy rate changes. While it doesn’t directly set mortgage rates, its policy rate adjustments affect short-term interest rates, including the prime rate used for variable-rate mortgages. Long-term interest rates can also be influenced by changes in the policy rate.

Inflation used to be a significant factor affecting funding costs, but since the Bank of Canada began targeting inflation, interest rates and inflation uncertainty have decreased, leading to lower funding costs. Personal characteristics and mortgage features also affect the total amount paid. Factors such as credit history and mortgage choices determine the level of risk lenders face. Higher risk typically leads to higher interest rates. Credit score plays a significant role.

If a mortgage exceeds 80 percent of the home’s value, mortgage default insurance is required. This insurance protects the lender from default risk and may lead to a lower interest rate compared to an uninsured mortgage with a larger down payment.

Interest rate risk and prepayment risk are additional factors. Opting for a longer-term fixed rate may provide security but comes at a higher cost. Prepayment risk refers to the potential loss of profits for lenders if borrowers repay the mortgage early. Open mortgages that allow early repayment generally carry higher interest rates than closed mortgages with prepayment restrictions.

Using a Mortgage Agent guide you for the best mortgage and situation is essential. Contact us.