Canadian mortgage rates are in a constant state of flux, impacted by a variety of factors. Looking back in recent history, the pandemic prompted a trio of interest rate cuts that brought the Bank of Canada’s benchmark interest rate down to 0.25 per cent. Since mortgage rates (and other interest rates for borrowers) are tied to the Bank’s benchmark rate, the move resulted in a housing boom that saw many homebuyers taking advantage of the low cost of borrowing. Lower rates also had other impacts – for one, the inflation rate soared, prompting the Bank to raise its benchmark rate again, in its campaign to bring inflation back to what it considered to be the “safe zone” of two per cent. Now, there are new factors potentially impacting interest rates, such as the tariff threat. Needless to say, interest rates are an evolving thing that homebuyers and owners need to keep their eyes on.
Market analysts have debated the Bank’s next move, but it really depends on a few factors. Indeed, in the Canadian housing market, the interest rate behind a mortgage is determined by a couple of aspects that can send it higher or lower. So, for now, everything that is unfolding in the overall economy, financial markets and monetary policymaking apparatus is affecting how much homeowners are paying in interest on their mortgages.
Let’s go into a little more detail about how mortgage rates are set.
How are Canadian Mortgage Rates Determined?
Now, there are two types of mortgages: variable and fixed.
A fixed-rate mortgage is the most popular type of mortgage since it assigns a fixed rate during the term of the loan, meaning that borrowers will only need to focus on a predetermined monthly payment (principal and interest). The mortgage rate for a fixed mortgage is influenced by the central bank bond yields and broader changes in the bond market.
Financial experts purport that the five-year bond can generally provide a glimpse into where fixed rates may be heading. So, if the five-year bond yields are edging higher, fixed rates may emulate this trend. On the other side of the equation, if the five-year bond yields are down, this might signal that fixed rates will fall.
A variable-rate mortgage is a category of home loan whereby the interest rate is not fixed and is tied to the Prime rate, so the rate on a variable-rate mortgage will fluctuate whenever the Prime rate does. The mortgage rate for this product is tied to lender Prime rates, which are impacted by the Bank’s benchmark rate, also known as the overnight lending rate.
But how does the central bank influence fixed mortgage rates? Financial institutions acquire government bonds to generate a fixed-interest income. With that being said, fixed mortgage rates will compete with bonds to attract capital, so everyone will monitor bond yields to determine how high or low to establish mortgage rates.
“Remember that your lender’s funding cost determines most of the mortgage rate. The cost of funding jumped in the early days of the pandemic as investors became nervous. Many simply wanted to hold on to their cash given how uncertain everything was. So, the funding that is normally easy for lenders to get slowed to a trickle. This drove up the funding cost, even as the Bank of Canada’s policy interest rate fell,” the institution wrote in a May 2020 paper.
Small Changes Can Mean a Big Difference
Indeed, once you have an elementary understanding of how Canadian mortgages function, you should gain a measure of expectations about where mortgage rates could be headed in the coming months and years. In other words, if you think rates might be on their way down, homebuyers may want to take advantage of a variable-rate mortgage. However, if rates are expected to rise for the foreseeable future, a fixed-rate mortgage may be preferable.
Many Canadians are feeling financially stressed about the current economic climate. Consult your financial advisor for advice specific to your situation and connect with a REMAX agent, who will help you navigate changing conditions in the Canadian housing market.