What is Semi-Annual Compounding in Canadian mortgages?
Canadian mortgages compound interest twice per year (every 6 months), not monthly like US mortgages. This affects payment calculations.
Why Semi-Annual Compounding matters
A calculator that compounds monthly overstates the payment on a Canadian fixed-rate mortgage. At the same stated rate the Canadian method gives a slightly lower payment, so a US calculator can distort affordability by enough to change an approval.
How is Semi-Annual Compounding calculated?
Semi-Annual Compounding example
Worked example
A 5% fixed rate compounded semi-annually has an effective annual rate of 5.0625%, which works out to the same cost as a monthly-compounded rate of about 4.949%. On a $500,000 mortgage over 25 years that is a payment of $2,908 a month.
How brokers use Semi-Annual Compounding
- Convert the stated rate to an effective annual rate with semi-annual compounding, then to a periodic rate for the payment frequency.
- Use the same method for the stress-test qualifying payment, otherwise GDS and TDS will not match the lender's.
- Variable-rate mortgages typically compound monthly, so check the product when you compare payments.
- Accelerated bi-weekly and weekly payments are the monthly payment divided by two or four.
More questions about Semi-Annual Compounding
Do all Canadian mortgages compound semi-annually?
Fixed-rate mortgages do, and the Interest Act prevents compounding more often than that. Variable-rate mortgages typically compound monthly.
How much difference does semi-annual compounding make?
It lowers the payment slightly compared with monthly compounding at the same stated rate. On a $500,000, 25-year mortgage at 5% the payment is $2,908 a month.