Mortgage lenders base their fixed rates off the bond market. The fixed interest rate borrowers pay is based on the current 5 year Canada bond yields. Banks use bonds as security against losses in their mortgage investing. Therefore, lenders set fixed rates based on their forecasted bond yield investments accounting for operational costs and forecasted losses. The higher the bond rates, the lower the bond yields, the lower your fixed-rate mortgage.
A fixed rate mortgage is a loan where the interest rate remains the same for the entire term of the mortgage. Even when the market fluctuates, the borrower’s interest and principal payments remain constant every month. This makes budgeting and planning easier and provides greater predictability and stability.
Fixed rate mortgages are among the most popular types of loans across North America. The amortization period is generally 25 years, though borrowers can choose any amortization below 30 years provided they can service the larger payments.
A first-time homebuyer has determined that they can afford a monthly payment of around $2,600 including mortgage principal and interest.
Based on this budget, we can figure out how much the first-time homebuyer can borrow given two different scenarios (not including down payment or closing costs).
Loan Amount Interest Rate Term Monthly Payment
$487,000 5% 30 years $2,600
$330,000 5% 15 years $2,600
Extending the fixed rate mortgage term from 15 years to 30 years would allow the first-time homebuyer to borrow $157,000 more for the same monthly payment.
Now, imagine that the first-time homebuyer has a great credit score and is approved for a $487,000 loan regardless of the amortization period. For a 30-year mortgage, the payments can be stretched over time but that will come at a price. For a longer mortgage term, the interest costs will be higher and therefore the overall cost of borrowing will be greater.
In comparison, a 15-year amortization period will demand higher monthly payments in order to condense the term. The benefit of this scenario, however, is that the overall costs will be lower. For the 15-year term, the first-time homebuyer will save more than $244,810 in interest.
Amount Interest Rate Monthly Payment Term Interest Total
$487,000 5% $2,600 30 years $448,679
$487,000 5% $3,838 15 years $203,869
In all cases, the mortgage payments are consistent month-to-month. The different scenarios are a matter of changes to the monthly payments, amortization period, and the overall costs in interest.
Predictability, Stability, Consistency
Every month, your mortgage payments will remain exactly the same. Other monthly bills like insurance or property tax will still fluctuate. Nevertheless, a consistent mortgage payment is hugely beneficial. It helps with budgeting and provides some degree of assurance on the future.
Potentially Paying More Overall
There is a higher chance that the overall costs of the mortgage will be higher on a fixed rate mortgage compared to other lender options. There are a few reasons for this possibility.
One reason is that interest rates tend to be higher on a fixed rate mortgage compared to a variable or adjustable rate mortgage; there is a premium to pay for cost insurance. When the homeowner is taking less of a risk on their mortgage, they are paying a higher price for the security.
Another reason is that there is a chance that the prime interest rate (the rate in which lenders base their variable and adjustable rate mortgages) will lower during the mortgage period. On a fixed rate mortgage, that beneficial dip will not be applied. That means that the interest rate paid is potentially higher than the current rate associated with prime.
A final note is that borrowers who are looking for the security of a fixed payment can choose a variable rate fixed payment option. This is only offered by a couple of lenders in the market and can be a great option for someone looking for the security of a fixed payment and the flexibility to benefit from any decrease in the prime rate.
Every homeowner’s financial and personal situation is different. Finding the right mortgage can be difficult, which is why it is important to work with an experienced broker who can provide sound advice. There are many available mortgage options. A fixed rate is just one of many. Need help finding the right mortgage option for you? Let’s be in touch!