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Real Estate Ramblings - How interest rates work

Interest rates have been a scorchingly hot topic of conversation for at about the past 19 months. I've written about this subject several times in the past.

Interest rates have been a scorchingly hot topic of conversation for at about the past 19 months. I've written about this subject several times in the past. However, based on the volume of questions that I get about them and the very common misunderstandings that I hear makes me believe that they need to be revisited again.

Interest rates are a fascinating subject. The rates at which money is lent have a profound effect on a capital based economy. Interest rates are also a far more complicated subject than they can appear at first glance. Talk to a mortgage professional or, better yet, someone who works in finance if you want to understand more. In this column I am going to very briefly explain the relationship between the Bank of Canada, retail lenders and consumers. I will also explain where we are now, how we got here and where we appear to be going and most importantly, how that should affect your real estate decisions.

First off what is the Bank of Canada (BOC) and what do they do? The BOC, with the charismatic and widely respected Mark Carney currently at its head, has the primary objective of controlling inflation. Their inflation target is two per cent. The tool they use to control this number as accurately as possible is called the key interest rate. The key interest rate is the target for the overnight lending rate. According to the BOC website: "The overnight rate is the interest rate at which major financial institutions borrow and lend one-day (or "overnight") funds amongst themselves; the BOC sets a target level for that rate." When you hear about the BOC raising or lowering rates, this is the rate that is being referred to. The key interest rate influences the rate at which retail banks will lend to consumers and businesses.

When faced with the recession that started in 2008, central banks around the world slashed their nation's version of their key interest rates. This was done as a stimulus measure. It was an attempt by central banks to get retail banks to start lending again in order to stimulate business investment, consumer spending and all of the other things that rely on a steady flow of credit to function properly in a free economy.

One of the many ways that banks make money is by borrowing at a lower rate than the rate at which they are lending. This is called leverage. How decisions made by the BOC affect you as a participant in the Canadian real estate market is defined by how lending institutions react to these changes.

Looking back through the rate mail that is sent to me faithfully by Invis, the "best rates" being offered tell a fascinating story about how retail banks have reacted to the recent moves made by the BOC. In April, two months ahead of any rate increases with the key interest rate holding at 0.25 per cent and prime holding at 2.25 per cent, a five-year fixed mortgage was being offered at 4.39 per cent. By June 1, the date of the BOC's first rate increase, a five-year fixed was offered at 4.49 per cent. That is when things got interesting.

The key interest rate is now 0.75 per cent. The five-year fixed rate on offer is now 4.09 per cent. Despite the BOC's continuing rate hikes, retail rates have actually dropped. The profit margin for banks has narrowed because of the increase, but they still want to do business. In a sense the Great Canadian Mortgage Sale carries on. The point that I am making is that whatever the BOC does with the key interest rate, how retail banks react to those changes is what will affect you. Even though the BOC is raising rates, retail banks still want your business and are thus willing to decrease their own margins in order to continue to provide people with mortgages.

Knowing how interest rates work is important to home buyers. The rate at which you borrow will affect the five year cost of your home significantly. If you are even thinking in the back of your mind that you may want to purchase real estate in the near future, it is well worth it to go and get pre-approved at the bank of your choice. Rates are incredibly good right now and a pre-approval will lock in your rate for up to 90 days. Happy shopping!

Kevin Kurjata is a Dawson Creek Real Estate Specialist with Remax Dawson Creek Realty. Go to www.kevink.ca/dawsoncreekmarketpeek.php for detailed information on the Dawson Creek real estate market. He can be reached at 250.719.3538 or by email at kevink@kevink.ca. He is currently accepting new clients.

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