Mortgage Rates

How Are Mortgage Rates Set?

Canadian homebuyers may be significantly impacted by rates. They have an impact on your ability to obtain a mortgage, your ability to pay it off, and other factors. Over the course of your mortgage, even a quarter of a percentage either way could result in thousands of dollars in savings or costs.

Where do interest rates come from? What factors affect mortgage rates? Why don’t they just stay low all the time? Interest rates are typically influenced by a variety of local, national, and international economic growth factors, but it is possible to track them down to main sources.

Mortgage rates are available in two forms variable and fixed.

  • Variable rates are closely related to lender prime rates, which are in turn directly impacted by the benchmark rate set by the Bank of Canada (BoC).
  • Fixed rates are primarily impacted by Bank of Canada bond yields and bond market fluctuations.

How does the Bank of Canada influence variable mortgage rates?

The interest rate that banks charge one another to cover their short-term daily transactions is called the overnight lending rate, and the Bank of Canada (BoC) sets the rate’s “target.” The “prime rate,” or “guiding” policy rate, is what banks charge their most valuable clients.

The BoC indicates to the banks that it expects them to adjust their prime rates when it adjusts its target overnight rate, which they typically do (but not always), passing on increases or decreases to their clients.

Numerous prime rate products with “floating” interest rates are available from banks, including variable rate mortgages and credit lines (such as HELOCs).

How do Bank of Canada bonds influence fixed mortgage rates?

Government bonds are purchased by banks as a low-maintenance (read: less expensive) source of fixed-interest revenue. On the other hand, the fixed mortgage rates they provide clients with require additional upkeep (it costs more to operate mortgage).

However, fixed mortgage rates compete with bonds on comparable terms to draw money (e.g., 2-year, 5-year, etc.), so they consider the yield of those less-expensive bonds to assist determine how high or low to set rates of more-expensive mortgages.

How are variable rates set?

Mortgage rates that fluctuate with changes in prime rates are determined by the prime rates used by the lending institution.

To compete with rival lenders, lenders will frequently offer their 5-year variable rate at a “discount off of prime” to their best clients. Each lender sets its own discount rates based on the profitability of its mortgage lending operations and what the market will bear to draw customers. Your lender discount is included in the variable rate you agree to, and it remains the same for the whole 5-year term of the loan.

How are fixed rates set?

Fixed mortgage rates are set at a (average) spread relationship of 1-2% over bond yields, with the 5-year yield serving as the industry benchmark.

Since the traditional term on which banks compete is a 5-year fixed rate mortgage, keeping an eye on 5-year bond yields might provide a decent indication of the direction fixed rates may take.

  • When 5-year bond yields are up, it usually means fixed rates will go up if the trend continues.
  • When 5-year bond yields decline, fixed rates typically follow suit, albeit banks will take longer to lower their rates in response.
  • The 5-year mortgage rates might change at any time because bonds are traded every day.
  • In contrast to bond yields, which fluctuate in lockstep, mortgage rates have a spread relationship that can be used to forecast future rates.

When you agree to a fixed mortgage rate, it is yours for the duration of the agreement and won’t change until the next renewal period.

What happens when rates go up?

Borrowing money costs more as interest rates rise. Higher interest rates will affect how much you’ll spend in monthly mortgage payments or how much house you can afford if you’re in the market for a home.

For instance, if you needed a $200,000 mortgage and the interest rate was 5%, your monthly payment for 25 years would be $1,163.21. (your amortization).

However, if your interest rate on the mortgage were 1% higher, at 6%, your monthly mortgage payments would be $1,279.62. If the interest rate is raised to 7%, your monthly payments will exceed $1,400. Therefore, the general trend is to save money and spend less, especially on large purchases like a home or piece of property.

Why do rates go up?

The main objective of the BoC is to control inflation. When it thinks the economy is in danger of experiencing an excessively quick expansion that could result in higher inflation, it moves to raise its benchmark rate.

A surge in economic growth, for instance, can result in a cycle of rising prices and wages and inflationary pressures, which might push interest rates further higher to stop a “unnatural” state of supply and demand.

Therefore, the BoC seeks to control growth and volatility with its benchmark rate to aid in balancing a number of economic issues.

What happens when rates go down?

Of course, the most obvious explanation is that borrowing becomes less expensive. Because lower interest rates translate into cheaper monthly payments or more “housing” that you can afford, purchasing a home or other property with a mortgage becomes more appealing.

There is a catch, though. Lower rates are a clear indication from the government’s central bank that the economy is faltering (are there job losses or wage reductions?) and that not enough individuals are making large-ticket purchases. Rate reductions can promote economic growth by making borrowing more appealing to consumers and businesses.

With low rates having the potential to last too long, vigilance is advised. The prolonged economic boost could put rates once more at risk of climbing due to inflation. The most challenging and crucial responsibility for the central bank is accurately predicting the balance of risks between warming or cooling our economy.


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