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Looking for the perfect mortgage?
How
are interest rates determined? |
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The rate
of interest a lender charges is primarily a function of how much the lender
pays for the money that they lend to you. Institutional lenders are required
to "match the books". What this means is that the deposits that a lender
has on hand must bear some relationship to the money being lent. For example,
if a bank has a 5 year GIC portfolio of $2,000,000 at 6%, then it will
be able to provide some percentage of that portfolio (depending on its
deposit ratio requirement that is based on its size, financial health,
etc.) to its mortgage department for lending at a rate above 6% per term.
The difference between the interest rate that a bank pays on deposits
and the interest rate it charges on its loans (i.e., including mortgages)
is its profit margin. This is why savings rates are always lower than
borrowing rates.
On a more
esoteric level, the key federal bank rate is considered to be an overall
barometer of interest rates. This is because all financial institutions
borrow money from the central bank on a daily basis in many forms.
When institutions
are taking in a large amount of deposits, they in turn have more money
to lend. This is known as a "loose money period". Conversely, when deposits
are down, the institutions are forced to reduce their real estate loans
or stop making mortgage loans entirely. This is called a "tight money"
period.
Tight money
periods make it difficult for banks to lend and therefore more difficult
for potential purchasers of real estate to buy.
Considering
the fact that few of us have the opportunity to see the future, a more
tangible consideration when looking at terms is not interest rate related
at all. If, for example, you are expecting an influx of income in the
upcoming months, perhaps in the form of a raise, a large tax refund or
estate settlement or significant commission income, you may want to negotiate
a term that is consistent with the receipt of new capital or income that
may be used to increase mortgage payments or even to pay down your mortgage.
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