When it comes to buying a new home or refinancing an existing mortgage, many people are eager to secure a lower mortgage rate. Lower rates can mean potential savings over the life of the loan. However, it’s essential to grasp that a reduced interest rate doesn’t guarantee a reduced monthly mortgage payment. In this article, we will delve into the factors that can influence your monthly payments.
1. Loan Amount
The loan amount is one of the most significant factors impacting your mortgage payment. Even with a lower interest rate, your monthly payment will likely be higher if you’re borrowing a larger sum of money. Conversely, if you’re borrowing less, you might still enjoy a lower payment, even with a higher interest rate.
For instance, if you’re purchasing a more expensive home or refinancing for a larger loan amount, your mortgage payment will rise, regardless of how low your interest rate is. So, a lower interest rate might not be as helpful when you’re borrowing more.
2. Amortization
The loan amortization period, or the number of years it takes to repay your mortgage, plays a crucial role in determining your monthly payment. Opting for a shorter loan term (e.g., 15 years) will result in higher monthly payments compared to a longer term (e.g., 30 years), even with a lower interest rate.
While shorter loan terms often come with lower interest rates, the shortened time to repay the loan leads to higher monthly payments. Therefore, a lower rate might not necessarily lead to a more affordable monthly payment if you choose a shorter term.
In today’s climate of higher interest rates, more borrowers are leaning toward longer amortization periods to maintain sustainable payments. Most mortgages offer pre-payment options, allowing you to make additional payments towards the principal. This can help with budgeting and reduce reliance on credit cards and lines of credit to cover regular household expenses.
3. Mortgage Default Insurance
In Canada, if your down payment is less than 20% of the purchase price, you typically need to pay for mortgage default insurance (there are three providers in Canada – CMCH, Sagen and Canada Guarantee). This is an extra cost that can be added to your monthly mortgage payment. A lower interest rate might not fully offset the costs associated with default insurance, potentially resulting in a higher total monthly payment.
The Mortgage Centre Guelph’s Recommendation
While a lower mortgage rate can lead to long-term savings on your mortgage, it’s essential to understand that it doesn’t always translate to a lower monthly mortgage payment. The interplay of factors like loan amount, loan term, additional costs (CMHC, taxes, insurance), points, and closing costs can influence your monthly payment, sometimes mitigating the impact of a reduced interest rate.
Before making decisions regarding refinancing or home purchase, conducting a thorough financial analysis is advisable, considering all relevant factors. This will help you assess the true effect of a lower mortgage rate on your monthly expenses and make an informed decision aligned with your financial objectives and circumstances.