There are many factors that influence the rate of interest a person or corporation pays on its debt. These range from a review of macroeconomics, social, and political issues to micro issues reviewing the person or corporation's ability to repay the debt. Let's review a few factors which influence interest rates.
Fixed Rates
Most fixed-rate debt, such as fixed-rate mortgages, are priced off of bond yields. The lender, such as a bank, is able to match its assets and liabilities by borrowing money in the bond market and lending it out to consumers or businesses at a higher rate. This "spread" is the profit earned by the lender on the loan and used to cover organizational costs and earn an overall profit for its shareholders.
Bond yields are reviewed and set in the market by investors and represent the rate required to take on the risk that they will be paid back. For example, a highly rated government bond will feature a lower interest rate than a highly speculative bond issued by an unproven technology company.
Government bond yields generally reflect that country's overall economic growth outlook, ability to repay based on its current debt loan, and the political stability and history of repayment. For example, currently, a bond issued from Canada features a much lower rate of interest than Greece as it is perceived by investors as less risky due to its better economic, fiscal, and political stability.
Variable Interest Rates
Many consumers and businesses also review their options and take on variable debt, which unlike fixed debt, can vary over the course of the loan. In Canada generally, lenders such as banks or other financial institutions, base their variable rates off of the prime rate. The prime rate is based on the Bank of Canada's overnight lending rate, again lent out at a slightly higher rate to reflect the profit required. The Bank of Canada's overnight rate is reviewed 8 times per year and reflects the bank's outlook and review of the economy, inflation targets, and employment. In a strong economy with prospects for high inflation, the Bank of Canada will raise the rates. In a weak economy with prospects for stable inflation, the Bank of Canada will keep rates steady or decrease them.
Generally for homeowners, taking on a variable rate mortgage can be seen as slightly riskier as your payments are subject to change should the prime rate increase. However, the trade-off is the rate, at least at first, is typically lower than a fixed-rate mortgage. Homeowners need to review their personal situation and risk tolerance when determining which route is best for them.
Mainstreet Equity Corp. is a publicly-traded (TSX: MEQ) residential real estate company in Canada. Mainstreet currently owns and operates properties in Surrey, BC; New Westminster, BC; Abbotsford, BC; Calgary, AB; Cochrane, AB; Lethbridge, AB; Edmonton, AB; Fort Saskatchewan, AB; and Saskatoon, SK.
Mainstreet provides affordable, renovated apartment suites to Canadians, and is committed to creating real value without diluting shareholder interests.