Mortgage, Money and Dream – Our thoughts on Canadian Mortgage Market
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When it comes to fixed rate mortgage then the rule of the game is well known – the lender will compound the interest semi-annually. In simple words if a broker offers you a 5% annual interest rate (i.e. quoted rate) that will translate to roughly 5.0625% annual effective interest rate, based upon twice a year compounding. Since you are paying monthly so your interest rate has to go through some more cooking and finally it goes down to 4.9486985% annually.

As far as fixed rates are concerned – they are compounded twice a year. Then we step into a bit grey area when it comes to variable rate. Most of the lenders prefer to follow their own procedure and they end up having different effective annual interest rates. Let us take the same 5% quoted interest rate and use it with 12 compounding – what we get is 5.12% effective annual interest rate. At the same time with twice a year compounding it would produce 5.0625%, so the difference is equal to 5.12% – 5.0625% = 0.0575% = 5.75 BPS (basis points). Now how exactly this translates to your mortgage payment?

This calculation did work on the online calculators provided by the big 5 banks. They all came up with two different sets of numbers. Based on a $500,000.00 loan with 5% quoted rate and 25 years amortization the monthly payment estimated by the banks calculators are different.

  1. RBC – 2,922.96 monthly payment.
  2. BMO – 2,922.95 monthly payment.
  3. TD – 2,908.02 monthly payment.
  4. CIBC – 2908.00 monthly payment.
  5. Scotia – 2,908.02 monthly payment.

The difference is $14.94 a month. If you change the quoted rate to 5.05% then that would result in $2922.27 payment each month. That comes to about $1300.00 (compounded) extra, in a five years term mortgage.

You, at this point should be able to punch your own numbers in those calculators. There are many lenders who allow semi-annual compounding on mortgage loans. So, it is not always a good idea just to look at the discounts but to read between the lines and comprehend what you are getting. It may be the case that the on-line calculator does not exactly reflect the policy of the bank but a call should get you the answer.

More information:

  1. RBC – Their web site fine print under “Rates and Terms” TAB says Interest rate is compounded monthly, not in advance.
  2. BMOThe interest rate for a variable rate mortgage is calculated monthly not in advance.
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