This article is part of Global News’ Home School series, which gives Canadians the basics they need to know about the housing market that they never learned in school.
Canada’s mortgage market can be “daunting” for newcomers at the best of times, experts tell Global News, but the modern borrowing landscape may have would-be buyers and homeowners facing renewal feeling cornered.
Higher interest rates from the Bank of Canada, combined with uncertainty about future hikes or when cuts might come, are complicating mortgage decisions for Canadians.
Choices are limited for many borrowers as they struggle to qualify for the mortgage amount or rate they need to afford a home, but experts say there are a few strategies you can put to work to pick the right option for your financial circumstances.
Here’s what you need to know about how mortgage offers work and how to navigate the complicated space and — hopefully — secure the best rate for your home.
How are mortgages calculated, anyway?
Victor Tran, broker with True North Mortgage and expert with Rates.ca, says there are a lot of factors that can go into the final rate you’re offered by a lender.
Whether you’re renewing, refinancing or buying a home, the strength of your credit profile, how much you put down upfront and even the closing date on your purchase can affect the rate you ultimately secure, he says.
Then there’s the Bank of Canada — the leader of monetary policy in Canada, which broadly sets the cost of borrowing for all Canadians, businesses and financial institutions in the country with its target for the overnight rate.
Many consumers understand that mortgage rates are tied in some form or another to the Bank of Canada’s policy rate decisions. When that benchmark rate rises or falls, homeowners can eventually expect to pay more on their mortgages.
But how and when mortgage rates react to the central bank’s moves can vary depending on the kind of loan. It comes down to what kind of mortgage the borrower holds.
Variable-rate mortgages are tied to the “prime rate” on offer at major Canadian banks, which is set according to the Bank of Canada’s policy rate. Currently, that prime rate stands at 7.2 per cent at Canada’s big six banks.
A variable mortgage rate rises and falls immediately in line with the Bank of Canada’s moves because they’re typically calculated as “prime” plus or minus a certain amount. For instance, if a homeowner has a variable-rate mortgage of prime minus 0.5 percentage points, their effective mortgage rate would be 6.7 per cent today.
The Bank of Canada’s rate decisions therefore have a fairly direct impact on variable mortgages; fixed-rate mortgages have a much more indirect connection to the central bank’s policy rate.
Shubha Dasgupta, CEO of Pineapple Mortgage, explains that fixed-rate mortgages are tied to the bond market. For example, a five-year, fixed-rate mortgage is based on the five-year government of Canada bond yield.
The fixed mortgage rates on offer tend to rise and fall with the bond yields, which is influenced by the Bank of Canada as well as other factors that affect the bond market.
Dasgupta says fluctuations in global financial conditions and even sentiments in the market — like expectations that the central bank rate will rise and fall — can be enough to move bond yields and therefore affect your mortgage rate.
“These circumstances, sentiments and impacts really generally happen prior to a Bank of Canada rate increase or decline,” Dasgupta says.
Homeowners with fixed-rate mortgages also don’t see their payments change with every fluctuation in bond yields. Their borrowing costs are fixed — as the name might suggest — and only adjust to a change in mortgage rates when they renew at the end of their term.
How long should you take out a mortgage for?
How long to set your mortgage term is another question in the market that’s been turned on its head as of late.
Mortgage terms in Canada typically range from a few months to 10 years.
Tran notes that many Canadians historically have gravitated toward the five-year fixed-rate mortgage. This model provides a bit of stability in payments for five years at a rate that’s typically more affordable than longer seven- or 10-year options.
In normal circumstances, Canadians can usually find a cheaper rate by opting for a shorter-term mortgage with the caveat that they’ll have to renew more regularly and risk facing higher rates at that time.
However, many rates on two- or three-year terms are actually higher than the five-year fixed options right now because of an inverted yield curve that’s seeing shorter-term yields outperform longer-term bonds.
So, should the five-year fixed rate still be the go-to option for Canadians? Not so fast, says Tran.
While the Bank of Canada has warned that its policy rate might still need to rise higher in the months to come, many economists are predicting that the rate hike cycle is finished with more economic weakness on the horizon.
Tran says it might be unwise for a homebuyer to take on a five-year term today with expectations that rates will drop in the coming years — effectively committing to today’s higher rates for the next half decade.
It’s a gamble, but Tran argues opting for a shorter-term rate that might cost more in the next few years could save a homeowner more in the long run if today’s decades-high rates come down before a five-year term expires.
“It just doesn’t make sense to lock yourself in for such a long term at peak rates,” Tran says.
“I would say the three-year fixed has been the most popular choice, and that’s almost been the sweet spot for a lot of people.”
Though homeowners with variable rates have faced the most immediate pain in the current rate hike cycle, these mortgages can provide relief as interest rates ease and also tend to have more flexible terms when it comes to breaking the mortgage.
Dasgupta says that for this reason, prospective buyers and mortgage renewers ought to consider more than just the rate itself when picking the most affordable option in the long term.
“The interest rate that you get into today may not be the same interest rate you want to stay in as interest rates begin to come down,” he says.
“Looking at what the exit cost or the prepayment penalties of that mortgage are, are going to also have significant impacts on your overall decision.”
Qualifying challenges are limiting the chance for negotiation
While posted mortgage rates are tied to certain benchmarks like the Bank of Canada’s policy rate or the bond yields market, the rate your lender ultimately offers you is negotiable.
The challenge in today’s market, Tran notes, is that qualifying for a mortgage is exceptionally hard for many Canadians — limiting the ability to shop around and negotiate a lower rate.
The mortgage stress test, which applies to all federally regulated lenders, means that those taking out a new mortgage or looking to renew with a new lender have to qualify for their mortgage at a rate of the contract rate on offer plus two percentage points.
Many Canadians are therefore forced to qualify for mortgage rates of more than eight per cent currently, boxing some out of the housing market entirely.
Canadians with mortgages up for renewal typically don’t need to requalify with their existing lender, and can just roll over their mortgage into another term with a new rate.
Tran says that because it’s hard for homeowners to qualify elsewhere, lenders will play “hardball” on existing mortgage renewals and likely won’t offer much better than the posted rates.
“They’re going to offer you something really high and they won’t negotiate and drop the rate until your mortgage is really at risk of leaving,” he says.
If you can secure a mortgage offer at another lender and present it to your bank, that could elicit a better offer, Tran says.
But if that’s not possible, he warns not to show your hand and let on that you’re stuck with your existing lender. Suggesting that you’re shopping around and waiting until it’s a few weeks before renewal date could prompt the lender’s mortgage retention specialists to bump the offered rate down a bit.
“That’s when they start to offer some incentives or discounts just to retain your business,” Tran says.
If your mortgage is coming up for renewal, or if you know you plan to buy in the near future, it’s never too early to reach out to a mortgage broker to start the process, Dasgupta argues.
With uncertainty in future interest rate direction, locking in a mortgage rate now that will last for up to 120 days can insulate consumers against future rate hikes, he notes, while still holding onto the chance to renegotiate for something lower if rates drop instead.
Even 12-18 months in advance is a good time to get a sense of what you can qualify for when it comes time to secure that rate, Dasgupta says.
A longer lead time can help you strengthen your mortgage application with an improved credit score or by putting more money aside for a down payment, he says. Existing buyers can look at the impact of accelerated payments on their mortgage principal to lessen the monthly cost when it comes time to renew into higher rates.
Dasgupta recommends having the necessary documents, like pay stubs, property records and employment letters, ready to go to take some of the burden out of what can be a stressful time for homeowners and buyers alike.
“The mortgage process can be very daunting, but not if it’s well-prepared for an advance,” he says.
“Having all of that readily accessible and available will really make this process more streamlined and ensure that you’re working towards your end goal, which is getting the best possible mortgage at the best possible rate.”
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