Why Do My Legal Docs have 2 rates?
Because of how fixed mortgage rate interest is calculated...
Example in legal documents:
8.25% compounded semi-annually, not in advance
8.282% annualized percentage rate
In Canada mortgage rates are calculated as a percentage “compounded semi-annually, not in advance”. However, by law the Government also requires lenders to present this rate as if it were an annualized rate. Mathematically, anytime you change a compounding period (in this case making it annualized), the rate will be different. So if you take 8.25% compounded semi-annually and annualize it, it becomes 8.282%.
Why is the rate higher when annualized?
It happens in the mathematical conversion from a semi-annual to an annual rate. It is simply MATH. The interest rate disclosed as “compounded semi-annually, not in advance” is CORRECT as that is how mortgage interest is calculated in Canada.
Why does the Government require the rate disclosed as annualized then? In interests of fair and clear disclosure. Mortgages are regulated by the Government in Canada, that’s a good thing for consumers.
Background on How Canada Calculates Fixed Interest
'Compounded semi-annually is an old English term, from the days when ledgers were kept by hand. The interest was calculated twice a year and added on to the principal owing, then payments were subtracted. Even though we now use computers, the same method exists.
'Not in advance' refers to the payment being collected at the end of a time period. If you are paying a mortgage, the June 1st payment pays for the previous month of May. It is the opposite of renting where the payment on June 1st pays for the month of June.
Loans and Investments work the same way when
Compounded by Different Periods
Ex: 8.25% compounded semi-annually
That SAME rate will look different depending on how it is compounded:
8.091% compounded weekly
8.112% compounded monthly