Not All Mortgage Rates Are Created Equal: The Hidden Cost of Compounding

When shopping for a mortgage, most people focus on finding the best mortgage rate. That makes sense — a lower rate can mean significant savings. But there’s a lesser-known factor that can quietly increase your borrowing cost, even if the mortgage rate looks the same across lenders:

How often your interest is compounded.

This detail rarely gets discussed upfront, but it can affect how much you actually pay over the life of your mortgage. And it’s why comparing mortgage rates without understanding how they’re structured can lead to an expensive mistake.

What Is Compounding, and Why Does It Affect Your Mortgage Rate?

Compounding refers to how often interest is calculated and applied to your mortgage balance. It’s not just a technicality — the frequency of compounding can subtly increase the true cost of borrowing, even if your mortgage rate doesn’t change.

Here’s how different lenders handle it:

  • Semi-Annual Compounding (the Canadian standard):
    Interest is compounded twice a year. This is the default for most fixed-rate and variable-rate mortgages in Canada. It’s also how mortgage rates must legally be quoted by lenders, giving borrowers a standard basis for comparison.
  • Monthly Compounding (used by some lenders like RBC for specific variable-rate products):
    Interest is compounded every month. That means interest is added to your mortgage balance more frequently — which increases the amount of interest you’ll pay over time, even if the mortgage rate appears to be the same.

If you’re comparing lenders, understanding how the mortgage rate is applied is just as important as the rate itself.

Mortgage Rate Comparison: A $500,000 Example

Let’s say you take a $500,000 mortgage with a 5.00% variable mortgage rate, amortized over 25 years. Here’s how much interest you’d pay after 5 years under different compounding schedules:

Compounding Method Total Interest Over 5 Years Effective Annual Cost
Semi-Annual $140,042 ~5.06%
Monthly $141,679 ~5.12%

The difference? Just over $1,600 in additional interest — caused by nothing more than how your mortgage rate is applied. Over a longer term or larger mortgage, that gap can widen further.

Why the Fine Print Behind Your Mortgage Rate Matters

Two lenders may offer you the same mortgage rate, but if one uses monthly compounding instead of semi-annual, you’ll quietly pay more in interest.

This is especially relevant with certain variable-rate mortgages. For example, RBC’s fixed-payment variable rate mortgage compounds interest monthly — and in a rising rate environment, that structure can lead to negative amortization, where unpaid interest quietly accrues.

If you’re comparing mortgage options, you need more than just the advertised rate. You need to understand how the rate behaves.

What to Ask When Evaluating a Mortgage Rate

  • Does the lender use monthly or semi-annual compounding?
  • How is the mortgage rate applied to my balance each payment period?
  • If I choose a variable-rate mortgage, will my payment adjust as rates change — or could unpaid interest start building up?

Final Thought

It’s easy to focus on the headline mortgage rate — but what’s behind that number matters just as much. Compounding frequency, payment structure, and how interest is calculated can all impact what you’ll truly pay.

If you’re looking at a variable mortgage rate, or even comparing fixed-rate options, make sure you’re not just getting the best advertised rate — make sure you’re getting the best structured rate.

Have questions about how your mortgage is structured, or whether your current lender is giving you the most cost-effective option? Let’s talk.

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