What to Know About Interest Rates Before Buying a Home

Buying a home is one of the biggest decisions you'll ever make, and understanding interest rates can be one of the most essential tips for first-time home buyers. It pays to know your options for types of mortgages and how different interest rates will affect both your short-term needs and long-term budgeting strategy. You may have heard horror stories of people who locked themselves into high-interest mortgages or saw their loan applications denied due to poor credit scores, but don't worry, there are ways to ensure that doesn't happen. This blog post will discuss what to consider when shopping for mortgage rates, how lenders decide on interest rates, and answer your FAQs about how interest rates influence homebuying.

For informational purposes only. Always consult with a financial advisor before proceeding with any real estate transaction.

What Are Interest Rates?

Interest rates are a critical tool to control how much money circulates within the economy. Essentially, interest rates dictate how much it costs to pay back a loan. The Bank of Canada is the primary entity responsible for adjusting the interest rate in response to economic conditions, determining how much the banks will charge borrowers and how much they will pay savers. This decision-making process considers many factors, such as demand for loanable funds, inflation, and prevailing interest rates established in other countries, such as the United States.

Since national rates influence all borrowing and lending, your mortgage's interest rates are closely aligned with country-wide interest rates.

Mortgage Payment and Interest Considerations

Most buyers are aware of the basic concepts conventional mortgages, even if they are first-time investors. Buyers typically offer a 20% down payment for a home, and a financial institution covers the remainder in the form of a mortgage loan. When comparing lenders and mortgage options, one may pay careful attention to how the mortgage's interest will be accrued and paid during the loan duration. This is where things can get a bit tricky, as there are two primary types of mortgages—fixed and variable.

Adjustable-rate mortgages (ARMs) have variable interest periods that may rise or fall, resulting in fluctuating interest rates. In contrast, fixed-rate mortgage payments typically remain consistent throughout the loan period. The majority of mortgages today are fully amortized, which means that borrower's making timely payments according to the amortization schedule will have their home paid off by the set loan ending date.

Amortization differs between ARMs and fixed-rate mortgages. Fixed-rate loans with fully amortized payments are considered an equal dollar amount, whereas with adjustable-rate loans, fully amortized payments will change along with interest rate changes. Regardless of how a home is financed, it's important to remember that lower payments often mean paying longer, so buyers can ultimately end up paying much more in interest alone for a home with a 30-year mortgage versus shorter-term options.

Is Mortgage Interest Tax Deductible?

While the rules for tax deductions are different for homeowners in Canada than one might be accustomed to in the United States, there are a few tax laws that can be taken advantage of within certain limitations. Generally, one cannot deduct mortgage interest for a private or principal residence. Should the home be sold, owners will qualify for a tax exemption on all capital gains from the sale. However, those interested in investing or building a portfolio can use a strategy to enjoy greater access to mortgage interest deductions.

Here's how the financial tax pros explain it in layperson's terms. Every mortgage payment is partially applied to both interest and the principal balance. This increases the owner's equity in the abode, which can be borrowed against. With some savvy guidance, one can often get a better rate on such loans than an unsecured loan.

Regarding tax deductions, if the funds borrowed against the home's equity are then utilized to buy an income-producing investment, interest on that loan can become tax deductible. Due to the complex nature of investment portfolios, deductions, and tax laws, it's recommended to seek the assistance of a financial professional who knows the Canadian tax code like clockwork.

Buying Now Versus Buying Later

Some buyers are stuck on getting the absolute lowest interest rates before buying, and others may also be trying to get a lot of homes for less money at the same time. While the strength of the real estate market and the bottom line prices on homes typically will vary throughout the year, there may not be any benefit for waiting around for lower rates or desperate sellers.

High interest rates eat up any savings reaped from buying a home after a price drop. Because interest rates can be unpredictable, those looking for a reliable, set mortgage payment might do themselves a favour by buying at a higher price with a lower interest rate. This is particularly true for those looking towards having long-term loans of 25-30 years.

Sitting down with a real estate professional and/or a financial planner will help buyers avoid the most common mortgage mistakes. In some cases with higher-end homes, one could potentially lose between $60,000-$100,000 or more if interest rates hike a mere 2%! Determining the right time to buy may ultimately lead to deciding based on financial savvy rather than personal preference.

Understanding Interest Rates: How Much Does a Loan Cost?

An inexperienced home buyer will benefit significantly by employing the assistance of real estate and financial tax professionals. Those who try to navigate the complexities of mortgages, interest rates, amortization, and tax laws might find themselves going underwater on their loan or, even worse—losing their investment entirely. Be sure to take advantage of local resources and professionals in the locality where you plan to buy a home or invest in real estate.

For informational purposes only. Always consult with a financial advisor before proceeding with any real estate transaction.