What does "compounded semi-annually" mean?
Compounding is how often the lender works out the interest owed and folds it into the balance on which the next round of interest is charged. A rate compounded semi-annually is converted into the monthly rate that, applied every month, gives exactly the same result as charging half the annual rate twice a year. A rate compounded monthly is simply divided by twelve.
The practical effect: with semi-annual compounding, the rate applied to your balance each month is slightly lower than one-twelfth of the quoted rate. With monthly compounding it is exactly one-twelfth. You still pay every month either way. Compounding only changes the rate used to calculate the interest portion of each payment.
Why does Canadian law care how the rate is stated?
Section 6 of the federal Interest Act covers mortgages repaid in blended payments, where each payment mixes principal and interest. It requires the mortgage to state the rate of interest "calculated yearly or half-yearly, not in advance". The aim is transparency: the borrower sees a rate expressed on a standard yearly or half-yearly basis, not one that hides extra compounding inside a friendly-looking number.
In practice, Canadian fixed-rate mortgages quote rates compounded semi-annually, and the convention is so settled that many quotes never mention it. Variable-rate mortgages are different: they commonly compound monthly, so the compounding line in the agreement is worth reading.
The same Act has another provision worth knowing. Under section 10, for an individual's mortgage with a term longer than five years, the borrower can repay after five years with three months' further interest. That matters if you are weighing a seven- or ten-year term against a five-year one.
How much does compounding change a real payment?
Take an illustrative $400,000 mortgage at 5.00% over a 25-year amortization, priced two ways. Compounded semi-annually, the lender applies 0.41% a month and the payment is $2,326.42. Compounded monthly at the same quoted rate, the lender applies 0.42% a month and the payment is $2,338.36.
Over the first year, the semi-annual version charges $19,608 of interest and repays $8,309 of principal. The monthly version charges $19,813 and repays $8,248. At the same quoted rate, monthly compounding always costs a little more, because interest is added to the balance more often.
| Compounded semi-annually | Compounded monthly | |
|---|---|---|
| Quoted rate | 5.00% | 5.00% |
| Rate applied each month | 0.41% | 0.42% |
| Monthly payment | $2,326.42 | $2,338.36 |
| Interest in year one | $19,608 | $19,813 |
| Principal repaid in year one | $8,309 | $8,248 |
| Share of year-one payments that is interest | 70.24% | 70.61% |
Does that make a variable rate dearer than a fixed rate with the same number?
At an identical quoted rate, yes, slightly. But fixed and variable offers don't necessarily carry the same rate, and they behave differently over the term: a fixed rate stays put, while a variable rate moves with the lender's prime rate. Compounding is one more reason to compare each offer with its own kind rather than reading two quotes side by side as if they were the same product.
The fixed mortgage checker and the variable mortgage checker each compare your rate with the Bank of Canada's effective rate on new mortgages of the same type. The dollar figures they show use semi-annual compounding for fixed rates and monthly compounding for variable ones, so the cost of a gap is measured on the right basis.
For the wider comparison, including how a variable payment behaves when prime moves, see fixed vs variable: how to compare offers and how variable-rate payments work.
How does compounding compare with a difference in rate?
Here is the same $400,000 mortgage, both versions compounded semi-annually, at 5.00% and at 4.75%. That 0.25% gap changes the monthly payment by $56.60 and the interest over a 5-year term by $4,802. You would also finish the term owing $1,407 more at the higher rate.
Set those figures beside the compounding difference in the table above to see the relative size of each on these illustrative numbers. To run your own balance, use the rate difference calculator or the mortgage payment calculator.
| At 5.00% | At 4.75% | |
|---|---|---|
| Monthly payment | $2,326.42 | $2,269.82 |
| Interest over 5 years | $93,615 | $88,813 |
| Balance after 5 years | $354,030 | $352,623 |
How do I check the compounding on my own mortgage?
If anything in the agreement is unclear, ask the lender to show how it calculates the interest portion of a payment. The glossary explains related terms such as amortization, blended payments and the interest rate differential.
- Find the interest-rate wording in your mortgage agreement or commitment letter and look for "compounded semi-annually" or "compounded monthly".
- Check whether the rate is fixed or variable and, for a variable rate, how it is set relative to the lender's prime rate.
- When you use a calculator, confirm which compounding basis it assumes: one that compounds monthly will slightly overstate the payment on a Canadian fixed-rate mortgage.
- Compare like with like in the checker, then turn any gap into dollars over your term.