The decision to buy a home is a big one, but the choice on which mortgage to take out to finance such a large investment is just as important. One detail in particular you’ll want to iron out is the mortgage rate, which directly impacts your overall mortgage cost. But the lowest rate isn’t the only factor to consider.
Other details require careful consideration as well. We’ll go into further detail about what those are to help you make a more informed decision when applying for a mortgage.
Key Points:
- The lowest mortgage rate isn’t always the most affordable option, as fees, penalties, and flexibility can be just as important.
- Factors like term length, amortization, prepayment privileges, portability, and refinancing options all affect the true cost of a mortgage.
- Early prepayment penalties can be expensive, especially with fixed-rate and closed mortgages.
- Borrower-specific factors and lender policies both play a key role in the rate you’re offered.
Is A Lower Mortgage Rate The Most Important Factor In A Mortgage?
The less you can pay overall, the better, right? Obviously, a huge part of how expensive a mortgage will be is the interest rate that you are charged.
Higher interest rates mean you’ll be paying more on the interest portion of your mortgage relative to the loan amount you’ve taken out. Conversely, a lower interest rate would mean you’d be paying less in overall interest over the life of your loan.
But that’s not the only thing you should be considering when shopping around for a mortgage. The thing is, some mortgages that come with a lower rate can sometimes cost you more overall compared to other mortgages that come with a higher rate.
There are other fees associated with mortgages aside from interest rates. Although interest plays a key role in mortgages and how much they cost borrowers, there are several other factors to include in the equation before determining which mortgage option is more affordable for you.
Factors Beyond The Interest Rate
While the interest rate you’re offered is a key factor, there are others that should be considered.
Term
A mortgage term is the length of time your mortgage contract is in effect, and typically ranges between 6 months and 5 years. It matters because it determines how long you’re locked into a specific interest rate, payment schedule, and lender conditions before you renew.
Amortization Period
A longer amortization reduces monthly payments but increases total interest costs. A shorter amortization may mean higher payments but saves thousands in interest over the life of the loan.
Prepayment Privileges
The ability to make lump-sum payments or increase monthly payments can significantly reduce your mortgage balance faster. This flexibility sometimes matters just as much as a slightly lower rate.
Portability
If you move, a portable mortgage allows you to transfer the mortgage to a new property without penalties. Without portability, moving could come with costly fees.
Refinancing Options
Some mortgages allow refinancing with minimal fees, while others lock you in. If you think you might need access to equity at some point or want to consolidate debt, refinancing flexibility is very important.
Customer Service
A lender’s responsiveness and transparency can make a big difference when issues arise. Poor customer service can add stress, despite having a lower rate.
Here are a few other things that you should take into consideration when choosing a specific mortgage.
Learn more: Features You Want To See In Your Mortgage Contract
Why Early Prepayment Penalty Fees Can Be Hefty
We briefly touched on prepayment privileges. The reason why this factor is important comes down to the potential penalty fees that may apply if you break your mortgage early or pay it down before the end of the term.
Every lender sets their own rules regarding prepayment privileges, but most allow borrowers to either increase their regular installment by a certain percentage or make a lump-sum payment up to a certain amount. The exact details of how you can use these privileges will be outlined in your mortgage contract.
The reason why lenders impose early prepayment penalties is to recover the interest income they lose when a loan is paid off ahead of schedule. Since mortgages are a source of profit, early repayment reduces their earnings. Penalties are designed to offset that loss.
How Prepayment Penalties Are Calculated
Generally speaking, penalties are determined in one of two ways. The fee is usually whichever amount is greater:
- Three months’ worth of interest on the outstanding balance.
- Interest Rate Differential (IRD), which measures the gap between your current mortgage rate and the rate available for a term that matches the time left on your loan.
| Note: The penalty you’re charged depends on your loan type: Fixed-rate mortgages: Lenders use either a three‑month interest charge or the IRD. Variable‑rate mortgages: Lenders usually use the three‑month interest method. |
How Open Vs Closed Mortgages Matter In Prepayment Penalties
A closed mortgage is a loan agreement that locks you into a set term and interest rate, limiting prepayments or early mortgage repayment without penalties. An open mortgage, on the other hand, is a loan that allows you to pay off the balance in full or make large prepayments at any time without penalties.
The biggest difference between the two is the level of flexibility. An open mortgage can be paif off at any time with no penalty, but closed mortgages have restrictions and come with penalties regarding prepayments.
Learn more: Open vs. Closed Mortgages
How Do Credit Scores Impact Mortgage Rates?
Your credit score has a direct impact on the type of interest rate you are able to secure. With a higher score, you can get a lower rate, making your overall mortgage more affordable.
The majority of conventional lenders require a minimum credit score of roughly 660 in order to approve a home loan application. Credit scores provide lenders with some insight into the financial behaviour of a borrower.
Lower credit scores are associated with a history of missed or late payments, which is exactly what lenders don’t want to deal with. On the other hand, higher credit scores are usually reflective of a clean payment history, which makes these borrowers less of a risk for lenders.
How Does Mortgage Insurance Impact Mortgage Rates?
Mortgage default insurance – also referred to as CMHC insurance – is a policy that borrowers have to pay on top of their monthly payments if they have a high-ratio mortgage. A down payment of less than 20% will require mortgage default insurance, which protects the lender if you fall behind on your mortgage payments.
Mortgage default insurance allows buyers with smaller down payments to qualify for a mortgage, and it typically results in lower interest rates compared to uninsured mortgages because the lender’s risk is reduced. However, the added insurance premiums will increase the overall cost of borrowing.
Why Do Different Lenders Offer Different Mortgage Rates?
You may find that different lenders offer different mortgage rates, which is why shopping for a mortgage before applying is crucial. There are several reasons why lenders have their own unique rates:
- Different Business Strategies: Each lending institution has its own funding costs, risk tolerance, and business strategy. Banks, credit unions, and alternative lenders may price loans differently depending on where they source funds, their overhead expenses, and competition levels in the lending market.
- Bank Of Canada’s Overnight Rate: The Bank of Canada determines and sets what’s known as the “target for the overnight rate,” which is the rate that banks charge one another to cover transactions they deal with every day. Banks use this rate as a guide when they set their prime lending rate, which is the rate that they offer their best clients when they borrow money. When this overnight rate changes, that triggers banks to change their prime lending interest rates.
- Borrower-Specific Factors: Just like every lender is different, so is each borrower. Every applicant may have a unique credit score, income level, and down payment size, which all influence the rate offered.
| In A Nutshell: Mortgage rates ultimately depend on both the lender’s policies and the borrower’s profile. |
Learn more: Why Do Different Lenders Offer Different Mortgage Rates?
What Happens If The Rate You’re Offered Increases While House Hunting?
If mortgage rates rise while you’re in the process of buying a home, the key is to stay flexible and strategic. Here are a few steps to take if you find that rates have ticked up after you’ve already started the mortgage and house hunting process:
- Ask About A Rate Hold: Contact your lender to see if they can lock in your rate for a few weeks until you finalize a deal.
- Compare Mortgage Products: Compare fixed vs. variable options to see if shorter or longer terms are better for you, depending on your risk tolerance.
- Review Prepayment Privileges: Check if the mortgage allows lump‑sum payments or accelerated payment schedules. This flexibility can help offset higher interest costs.
- Use A Mortgage Broker: Brokers can shop with multiple lenders on your behalf to find the best offers.
- Stay On Top Of Market Trends: Keep tabs on Bank of Canada announcements and bond yield movements to help you anticipate any rate changes in the near future so you can act accordingly.
- Consider Timing: If rates are expected to increase soon, consider securing a mortgage sooner rather than later to save money.
Learn more: What Do I Do If Mortgage Rates Increase While I’m Trying To Buy A House?
How To Get A Low Mortgage Rate
While a lower rate might not be the only factor to consider, it’s certainly an important one that ill affect the overall cost of your home loan. If you’re wondering how to get a lower mortgage rate, consider the following tips:
- Improve Your Credit Score: Pay your bills on time, reduce your debt, and avoid new credit inquiries to give your credit score a boost.
- Save For A Larger Down Payment: Putting down 20% or more reduces the lender’s risk and may result in a lower rate.
- Choose A Shorter Amortization: Shorter repayment periods often come with lower interest rates.
- Shop Around: Compare offers from banks, credit unions, and alternative lenders to find the lowest rates.
- Lock In Rates Early: Secure a rate hold to protect against increases while house hunting.
Final Thoughts
If you’re in the market to take out a mortgage, you’d be well advised to do some shopping to make sure you find and choose the right mortgage product for you. At Loans Canada, we can help you connect and compare various mortgage lenders to find one that best suits your situation.
FAQs
What hidden costs can come with a low-rate mortgage?
How do prepayment privileges affect the value of a mortgage?
How does the mortgage stress test affect rate decisions?
What’s the difference between fixed and variable rates when considering the lowest rate?
When might a slightly higher rate be better?
Does the Bank of Canada directly set interest rates on mortgages?
Note: Loans Canada does not arrange, underwrite or broker mortgages. We are a simple referral service.
