Buying a house will undoubtedly be the most significant transaction of your life. Like most people, you won’t pay cash: you’ll apply for a mortgage that will cover most of the purchase price. And during the term of this loan, you will pay a lot of interest.
The slightest variation in rates can significantly change the total amount you will pay. Therefore, it is essential to understand what determines the speed of your mortgage, even if you are already a homeowner.
Certain factors affect the cost of all mortgages.
You can compare a mortgage to any product you buy. Any business that sells a product seeks to make a profit. Therefore, the price she asks for this product must be higher than what it costs her. It’s the same for the lender: he makes a profit on the loan he gives you because you pay more interest (the price he asks you) than what it costs him to borrow this money (financing cost).
The cost of financing is what influences your mortgage credit the most. Other factors come into play, such as the lender’s operating costs and how much they need to cover the risk of you not repaying the loan, but the cost of financing remains the most critical factor.
So what determines this cost?
The economic situation in Canada and abroad has a significant impact.
Funds slow by banks come from depositors and investors in Canada and other countries. Thus, the cost of financing depends a lot on the interest rates offered here and abroad, which go up and down for various reasons.
Strong economic growth leads to increased demand for funds.
Strong economic growth raises rates, while weak growth lowers them. Why? Because when the economy is strong, more companies seek funding from investors to finance their expansion. Therefore, mortgage lenders must offer higher interest rates to investors to induce them to lend them funds rather than pass them on to another business. When the economy is sluggish, the opposite happens.
The global economy comes into play.
Many Canadian banks borrow funds from other countries, particularly the United States. And because global financial markets are interconnected, interest rates in Canada are influenced by what is happening elsewhere. For example, when overseas rates fell in 2019, Canadian five-year fixed-rate mortgage rates also fell.
The Bank of Canada influences interest rates.
The Bank of Canada also influences interest rates, mainly by changing its key rate.
The Bank may raise this rate to prevent inflation from overshooting the target when the economy is doing well. Conversely, it must sometimes lower this rate to prevent inflation from falling below the target when the economy slows down. Changes in the policy rate lead to similar movements in short-term interest rates, such as the prime rate used by banks to establish variable mortgage rates. These changes may also affect long-term rates, particularly if the new policy rate is expected to be maintained.
In the past, high and variable inflation lowered the value of money. To compensate, investors demanded higher interest rates. The cost of financing was, therefore, higher for mortgage lenders. But since the Bank of Canada began inflation targeting in the 1990s, interest rates and inflation uncertainty have declined. As a result, the cost of financing is now much lower.