Many people are not aware of the various factors that can affect mortgage interest rates. Once you have a better understanding of these factors, it will improve your knowledge of the way the mortgage money system operates, and increase your confidence and skill when selecting and negotiating your mortgage.
Here are some of the key influencing factors:
Federal government policy
Through the Bank of Canada–the central bank–the federal government sets the prime bank rate. This is the rate that the Bank charges on short-term loans to financial institutions. The rate is set each week on Tuesday, at 25 basis points above the average yield (interest return) on three-month treasury bills. The government auctions these bills weekly. One hundred basis points represents one per cent interest, therefore 25 basis points would represent 0.25 per cent interest. Conventional lenders such as banks, trust companies and credit unions adjust their prime rates and mortgage rates using the federal bank rate as a guide. The central bank rate therefore sets a trend throughout the system. There are various factors, as well as political and economic dynamics, which influence the federal bank rate.
Excess or shortage of money
There is a natural connection between the general economic cycle and the real estate cycle. The willingness of people to place money in a savings account is where the pool of mortgage money is created. A situation where the inflow of deposit funds is high (at RRSP time for example), the interest rates are low, and the lender has funds to lend is referred to as a “loose money” market. This has a positive effect on the real estate market. In this situation, real estate activity can be expected to increase, as more people will be able to afford financing and purchase a home or other real estate investment. As there is more activity in the market-place, there is a dynamic of supply and demand, and real estate prices can be expected to rise.
On the other hand, if the public thinks it can get a better return on other forms of investment than deposit funds (in a low-interest situation, for example) then the lenders are left with a shortage of money to lend for mortgage or other loans. This is referred to as a “tight money” market. The lender may reduce lending mortgage funds in many cases and be selective about where the money is loaned.
Type of lender
Rates vary among lenders, depending on their policies and restrictions. A more conservative lender may charge a higher rate than another. In general terms, conventional lenders, such as banks, trust companies and credit unions, tend to be fairly competitive in the rates they charge for mortgages. A private mortgage lender generally wants a greater profit, and will therefore charge more.
Quality of borrower
Lenders assess the credit-worthiness of the borrower and the ability to pay back a loan. A borrower with fewer assets, recent employment or self-employment, or a spotty credit record will pay a higher rate of interest than a borrower that has the opposite profile. This is reflected in the case of loans to a business. The lowest-risk/no-risk customer could receive the prime (lowest) rate of interest for a loan, while higher risk businesses could pay from prime plus one to prime plus six per cent.
