There’s a lot of buzz around surging interest rates, fluctuating inflation trends, and whispers of impending recession. These things can affect your mortgage, but understanding how isn’t always straightforward.
We know that interest rates play a big role in setting mortgage rates. But it’s not just a simple connection. Fixed-rate mortgages, for example, are linked to the Government of Canada’s 5-year bond yields, which are influenced by what’s happening with the U.S. Treasuries. Meanwhile, variable-rate mortgages are tied to the Bank of Canada’s decisions about interest rates, which then affect what banks charge for loans.
To really understand where mortgage rates are heading, it helps to break down the differences between bonds and Bank of Canada rates a bit more. So, let’s take a closer look at how these factors work together to shape what you pay for your mortgage in terms of your interest rate.
What Are Government Bonds?
Imagine bonds as loans you make to different entities, like governments or companies, for a specific period. They promise to pay you back a fixed amount of interest until the loan matures, which could be 1, 5, 10, or even 20 years.
Now, when interest rates go up, new bonds offer higher interest rates, making older bonds less attractive. At the end of the loan period, you get back your initial investment.
There are different types of bonds, like government bonds and corporate bonds. The return you get on a bond is called its yield, usually shown as a percentage.
For example, if you buy a $1,000 bond with a 5% interest rate, your yield is 5%.
You can also buy and sell bonds after they’re issued. If a bond is in high demand, its price goes up, but its yield goes down. And if it’s not in demand, its price goes down, but its yield goes up.
So, think of it like this: when bond prices are high, their yields are low, and when prices are low, yields are high. It’s all about balancing supply and demand in the market. Bond markets are quite complex, but this gives you a basic idea of how they work.
Why Do Bond Yields Affect Mortgage Rates?
In simple terms, banks use money from depositors to fund mortgages. They also invest in government bonds because they offer a safe and predictable source of income. Variable-rate mortgages rely on short-term funds, while fixed-rate mortgages use longer-term funds.
The 5-year bond yield plays a big role in setting fixed mortgage rates. When bond yields go up, so do fixed-rate mortgages. For example, the 5-year bond yield went from a low of 0.306% in August 2020 to a high of 4.466% in October 2023. Currently, it’s around 3.75%.
Lenders, like banks or credit unions, use the 5-year bond yield as a guide for fixed-rate mortgages. They add a “risk premium”, usually 1% to 2%, based on their assessment of risk and competition.
During the pandemic, the Bank of Canada influenced fixed mortgage rates indirectly. It bought Government of Canada bonds through a policy called quantitative easing, which pushed up bond prices and lowered yields. Now, with the economy heating up, the bank has stopped this program, which is called quantitative tightening.
How the Bank of Canada Affects Variable Interest Rates
The Bank of Canada is like the country’s financial guardian. It aims to keep prices stable by controlling how much the dollar is worth. Their goal is to keep inflation—the rising cost of things—under control at around 2%.
To control inflation, the Bank changes its main interest rate, called the overnight rate. If prices are going up too fast, they raise this rate. This makes borrowing money more expensive, which slows down spending and helps keep prices from rising too quickly.
Banks use something called the prime rate, which follows the overnight rate, to set interest rates on things like mortgages. So, if the Bank raises its rate by 0.25%, the prime rate also goes up by 0.25%.
The inflation rate has been fluctuating over the past year with a high in July 2023 of 8.1%. Now, the Bank’s actions to reduce inflation, like buying fewer government bonds, are starting to work. Though progress has been slower than expected, changes in interest rates affect the economy within 1.5 to 2 years, but mortgage holders feel them right away.
Other Factors That Affect Your Mortgage Rate
When you’re thinking about getting a mortgage, it’s important to understand what influences the interest rates you’ll be offered. It’s not just about economic factors; there are other things at play, too.
- Credit Risk and Credit Scores: Lenders look at things like your credit score, credit history, and how much debt you have compared to your income. If you have a higher credit score and a lower risk profile, you’re more likely to get lower mortgage rates because lenders trust you to pay back the loan.
- Down Payment Size: A bigger down payment shows you’re serious about the investment and lowers the risk for the lender. So, if you can make a larger down payment, you might qualify for better rates than someone with a smaller down payment.
- Loan Term and Type: Generally, shorter-term mortgages have lower rates than longer ones. And whether you pick a fixed-rate or variable-rate mortgage can also affect the rate, with each having its own pros and cons.
- Competition: The mortgage market is competitive, with lenders trying to attract borrowers, to do this they may adjust their rates to stand out. That’s why it’s smart to shop around and compare rates from different lenders. Even a small difference in interest rates can make a big impact on how much you pay for your mortgage over its life span.
When It Comes To Mortgage Rates, I Can Help You Find The Best Options and Rates
Various factors influence mortgage rates in Canada, from economic conditions and central bank policies to individual credit profiles and market competition. Trying to understand them all can be overwhelming but, working with a knowledgeable mortgage professional, like myself, can provide you with valuable insights tailored to your unique financial situation. Knowing about interest rates and how they affect your mortgage is a key part of my job. Finding the best mortgage rates available for you is what makes my job rewarding. Call me today at 705-315-0516, or book a consultation at this link, and we can talk about interest rates, mortgages, and finding the perfect financing solution to help you buy the home of your dreams.