An interest rate is the amount of interest charged on a monthly loan payment, expressed as a percentage. It is based either on the rate the Bank of Canada charges to lend money to money lenders or on bond yields. Interest rates are generally lower if you borrow money for a short period of time and higher if you borrow the money for a longer period of time.
Fixed Rate Mortgage
When you agree to a fixed rate mortgage, your interest rate will never change throughout the term of your mortgage. There are no surprises as you’ll always know exactly how much your payments will be and how much of your mortgage will be paid off at the end of your term.
Variable Rate Mortgage
When you agree to a fluctuating interest rate for the length of the term, then you have a variable rate mortgage. Interest rates fluctuate with the bank’s prime lending rate, and may vary from month to month. When interest rates change, your payment amount remains the same, however the amount that is applied to the principal will change. For example, if interest rates drop, more or your mortgage payment is applied to the principal balance owing. The variable rate mortgage is a good option for homeowners who believe that interest rates are currently high and will drop.
The term of a mortgage is the length of time a lender will loan mortgage funds to a borrower. This duration can be from six months to ten years, two to five years being the most common. Generally, the shorter the duration of a mortgage term, the lower the interest rate, and the less it costs to borrow the money. At the end of each term, you will either pay off the balance owing or renegotiate the mortgage for another term until the entire mortgage is paid back.
Short term agreements or mortgage contracts are usually for two years or less. Short term mortgages offer a lower cost of borrowing (interest rate) than a longer term. People who believe that interest rates are currently higher than they will be in the future generally choose a short term mortgage. They anticipate that interest rates will be lower at the time of renewal.
Long term agreements are generally for three years or more. Long term mortgages cost a bit more than short term mortgages, so the interest rate will be higher. A higher interest rate appeals to borrowers who value the stability and predictability of fixed expenses over a set period of time. A stable mortgage payment is easier to budget and offers peace of mind.
It can take a long time to completely pay off your mortgage – usually from 15 to 25 years. The process of fully paying off your loan by installments of principal and interest over a definite period of time is called Amortization. In recent years, mortgage lenders and insurers have offered consumers longer amortization periods of 30, and 35 years.
There are many ways of repaying your mortgage. Some people find comfort in a pre-determined fixed rate – it helps them budget and plan for other things in their life. Some people desire more flexibility in their repayment – their circumstances might include fluctuations in their cash flow, and they may want to make larger payments whenever possible. Different kinds of mortgages appeal to the different types of borrowers. Your mortgage professional can help you decide what is best for you.