Mortgage Interest Rate

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Rates are either locked or floating. Locked rates are referred to as “fixed rates”. Floating rates come in two flavours: “variable” and “adjustable”.

Locked-in or Fixed rates are unchanged over a contract duration. They fluctuate in tandem with bond rates that are set by financial markets. Many people mistakenly believe that the government sets bond rates, but this isn’t the case.

Floating mortgages rates are calculated monthly using the Prime Rate, the industry term for these are Variable Rate Mortgages (VRM) or an Adjustable Rate Mortgage (ARM). The Prime Rate is a floating rate set by each bank that can change monthly so that the interest charged on a floating rate mortgage can vary from month-to-month even though the monthly payment stays the same.

The mortgage payment on a VRM is set at the beginning of the contract term based on the beginning contract rate and then stays fixed for the duration of the contract term.

When a floating interest rate increases (or decreases) with the Prime Rate, the amount of your mortgage paid down changes downward (or upward). Below is an example using a $500,000 mortgage to illustrate the impact of a rate change.

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In a rising interest rate environment this might result in a borrower falling behind on their loan repayment during a contract term and then having to make up the difference in the subsequent term by increasing their payments.

Benefits of Locked-in vs. Floating

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When you agree to a fixed interest rate, the interest rate will not change for the duration of the contract so you can accurately predict how much interest you will pay over the term.
With a floating rate, you setup constant monthly payments but the interest rate may change, so you won’t know exactly how much will be paid off at the end of the term.
An adjustable-rate mortgage (ARM) increases/decreases your regular mortgage payment as interest rates change to keep your mortgage repayment schedule on track.

Key Facts:

  • 2 in 3 Canadians choose fixed rate mortgages.
  • For fixed rate mortgages, a longer term will usually have a higher interest rate.
  • For floating rate mortgages a longer term will usually have a lower rate.
Pay close attention to the floating rate quoted by lenders because not all lenders use the same “Prime Rate” rate. Some lenders have a higher prime rate specifically for mortgages. For example, at the time of writing this article TD Mortgage Prime Rate was 0.15% higher than the regular TD Prime Rate used for other floating loans. The difference between the two is small but significant. Over the course of a year the difference in rates could save you hundreds of dollars.

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