What Determines the Interest Rate on Your Mortgage?

General Mohsen Ravankhah 29 Feb

Buying a home is a significant financial milestone, often accompanied by taking out a mortgage to finance the purchase. The interest rate on your mortgage plays a crucial role in determining how much you’ll ultimately pay over the life of the loan. Let’s delve into the factors that influence this rate, shedding light on the intricacies of mortgage financing.

The Economics Behind Your Mortgage Interest Rate

1. Funding Cost: The Core Element

  • Think of your mortgage as a purchased product. The interest you pay is the price, and the lender aims to make a profit. The primary factor influencing your interest rate is the lender’s funding cost.
  • Funding costs are derived from the money lenders borrow, and they are largely influenced by the state of the economy in Canada and globally.

2. Economic Conditions and Global Impact

  • Economic growth directly affects interest rates. Strong growth leads to higher rates, while weak growth results in lower rates. This dynamic is driven by increased demand for money during economic expansions.
  • The global economy, particularly in countries where Canadian banks borrow money, also impacts interest rates domestically. Interconnected financial markets mean that changes abroad can influence rates at home.

3. Bank of Canada’s Role

  • The Bank of Canada plays a crucial role in influencing interest rates through its policy rate. While it doesn’t directly set mortgage rates, changes in the policy rate can lead to adjustments in short-term and long-term interest rates.
  • Inflation targeting by the Bank of Canada has contributed to lower uncertainty about future inflation, resulting in reduced funding costs for mortgage lenders.

Factors Unique to You and Your Mortgage

1. Repayment or Credit Risk

  • Your credit history significantly influences your interest rate. A higher credit score can lead to a lower rate, reflecting your reliability in repaying debts.
  • Mortgage default insurance may be required for mortgages exceeding 80% of the home’s value, impacting your interest rate.

2. Interest Rate Risk

  • Mortgage terms vary, with most loans renegotiated every five years. The frequency of renegotiation affects the risk of facing different interest rates. Opting for a longer fixed rate may come with a premium for stability.

3. Prepayment Risk

  • Lenders face the risk of losing money if you repay your mortgage early. An “open” mortgage, allowing early repayment, typically carries a higher interest rate than a “closed” mortgage with prepayment restrictions.

The Importance of Shopping Around

In the mortgage market, competition is your ally. Shopping around and negotiating can help you secure a lower interest rate. With various lenders to choose from—large banks, regional banks, credit unions, or mortgage financing companies—you have the power to find the best deal that suits your financial goals.

Remember, understanding the factors influencing your mortgage interest rate empowers you to make informed decisions. As you embark on your homebuying journey, take the time to explore options, compare rates, and choose a mortgage that aligns with your financial aspirations.

 

The RRSP FAQ – Your RRSP Journey: Frequently Asked Questions Explored

First Time Home Buyer Mohsen Ravankhah 7 Feb

1. How much contribution room do I have? And do things like pension deductions, group plans, or dividends affect that room?

Every year, you build a contribution room—either 18% of your income from the year before or the annual cap (2023’s is $30,780; 2024 will increase to $31,560), whichever is smaller. The CRA includes your RRSP limit every year in your Notice of Assessment. Any room you don’t take advantage of carries forward indefinitely, so even if you can’t save it all now, you can catch up later.

If your employer has a group RRSP, any money you receive from it counts against your cap. It’s the same for registered pension plans and deferred profit-sharing plans, although contributions count against your limit the year after they are made in those cases. Interest, capital gains, and dividends don’t affect contribution space.

 

2. What happens if you over-contribute to your RRSP?

It’s not the end of the world, but it will cost you. The CRA gives you a lifetime buffer of $2,000. Once you exceed it, you’ll pay a penalty of 1% of the excess amount each month. In case that doesn’t scare you straight, you’ll also have to fill out a T1-OVP form, which nobody wants to do.

 

3. Do RRSP funds have to be used for retirement?

RRSPs are a lot more flexible than people realize. You can take your money out at any time and for any reason. But unless that withdrawal is to purchase your first home (using the Home Buyers’ Plan) or go back to school (with the Lifelong Learning Plan), you will be taxed on it at your marginal tax rate at the time of withdrawal, like regular income.

 

4. As someone new to Canada, I have never filed taxes, which means I cannot start an RRSP. What is the best way for someone in my position to reduce my taxable income?

Although it won’t reduce your taxes this year, you could open a TFSA to allow your investments to start growing tax-free. Any resident of Canada who has a valid SIN and who is at least 18 years of age is eligible to open one. Once you do file taxes, you’ll know exactly how much RRSP contribution space you have, and you’ll be able to open and contribute to an RRSP at that point.

 

5. When should you use spousal RRSPs?

Spousal RRSPs are a special type of RRSP that can be helpful when one spouse has a meaningfully higher income than the other. That’s because, in a graduated tax system, each person should have $40,000 of income rather than $65,000 and the other $15,000. With a spousal RRSP, couples can more evenly contribute to their accounts so that one person doesn’t have a substantially larger RRSP in retirement and, therefore, ends up in a higher tax bracket when they withdraw their money. The lower-income-earning spouse owns the spousal RRSP, which is contributed to by the higher-income-earning spouse and counts against the contributing spouse’s RRSP contribution room.

Not sure if a spousal RRSP is right for you? We made a flowchart to help. See below.

 

6. If I take a sabbatical year and am not working, could I withdraw from my RRSP to cover living expenses?

Yes, you can. Anything you take out when you are not working would likely be taxed at a much lower rate, assuming you have no other sources of income. Just remember, you don’t regain that contribution room like you would with a TFSA.

By: Wealthsimple