Unboxing the Mystery Behind Canadian Mortgage Rates

Mortgages play a crucial role in the Canadian housing market, enabling individuals and families to achieve their homeownership dreams. Understanding how mortgage rates are determined is essential for potential homebuyers and those seeking to refinance their existing mortgages. While mortgage rates may vary from lender to lender, they are influenced by a range of factors that shape the Canadian financial landscape. In this article, we will explore the 5 key elements that contribute to the determination of mortgage rates in Canada.

The Bank of Canada's Overnight Rate

The Bank of Canada (BoC) is the country's central bank responsible for managing monetary policy. One of the key tools at its disposal is the overnight rate, which is the interest rate at which major financial institutions borrow and lend money among themselves. Changes in the overnight rate influence the cost of funds for lenders and serve as a benchmark for mortgage rates. When the BoC raises or lowers the overnight rate, it can impact the interest rates offered by banks and other mortgage lenders.

The main reason the BOC raises and lowers interest rates is to control inflation.?“The biggest driver to inflation today, ironically, is mortgage rates, with a year-over-year increase of 30%. Stripping that out, today’s inflation rate would be just 2.5%, right around the Bank’s target range. Therefore, as the other main inflation drivers show a steady downward trend, cutting rates will help further reduce inflation moving forward.,” says Steve Foot, Managing Partner with IQ Commercial Mortgage.

Bond Yields and Market Conditions

The Canadian bond market also plays a significant role in determining mortgage rates. Government of Canada bonds serve as a reference point for long-term interest rates. Mortgage lenders often rely on the yield of Government of Canada bonds with similar terms (such as five or ten years) to determine the rates they offer. If bond yields rise, mortgage rates tend to follow suit. Conversely, falling bond yields can lead to lower mortgage rates. Market conditions, including supply and demand dynamics, investor sentiment, and global economic factors, can impact bond yields and subsequently influence mortgage rates. It is important to note that the bond markets try to predict the change well in advance of the BOC’s announcement.

Lender-Specific Factors

While broader economic factors significantly influence mortgage rates, individual lenders have their own considerations that affect the rates they offer. Each lender assesses various risk factors, such as creditworthiness, loan-to-value ratio, and borrower income, to determine the interest rate on a mortgage. Lenders may offer different rates based on their risk appetite and competitiveness in the market. Borrowers with strong credit profiles, stable income, and a larger down payment often qualify for more favourable rates.

Mortgage Term and Type

The term and type of mortgage selected by the borrower can impact the interest rate. In Canada, mortgage terms typically range from six months to ten years, with the most common terms being five years. Shorter-term mortgages generally have lower interest rates but require more frequent refinancing. Fixed-rate mortgages provide stability as the interest rate remains constant throughout the term, while variable-rate mortgages are tied to the lender's prime rate and can fluctuate with changes in the market. Adjustable-rate mortgages can also be influenced by factors such as inflation and lender-specific policies.

Government Regulations

Government regulations and policies also influence mortgage rates in Canada. Measures implemented by regulatory bodies, such as the Office of the Superintendent of Financial Institutions (OSFI), can impact lending practices and affect the rates offered by lenders. For example, the introduction of stricter mortgage stress tests aimed at ensuring borrowers can handle higher interest rates may influence the rates available to potential homeowners.

In conclusion, Canadian mortgage rates are influenced by a combination of factors, including the Bank of Canada's overnight rate, bond yields, lender-specific considerations, mortgage term and type, and government regulations. While the Bank of Canada's actions and the bond market provide a foundation, individual lenders assess borrower risk and competitive dynamics to determine the rates they offer. As a prospective homebuyer or someone considering refinancing, keeping an eye on these factors can help you navigate the mortgage market and make informed decisions.