How are mortgage rates set?

Trends, influences, real numbers.

Mortgage interest rates may seem mysterious and crafty. Here's how they work, and how you can keep track of what they're doing (to a point).

Updated March 2, 2021

Let's pull back the curtain. What wizardry is behind mortgage rates?

Mortgage interest rates going up? Going down? Staying put? It can be an all-consuming obsession (well, it is for us!). Rates can have a substantial impact on Canadian home buyers — in getting a mortgage, affording a mortgage, paying off a mortgage ... you get the idea. Even a quarter of a percentage could save thousands, or cost more, over the life of your mortgage.

Where do rates come from? What influences mortgage rates? Why can't they just always stay low (like they have been for this past while)? Interest rates are usually affected by several economic growth factors, nationally and globally, but can be taken down to primary sources to keep track of them.

There are two types of mortgage rates: variable and fixed. Variable rates are tied to the prime rate. Fixed rates are a bit more complicated, as they're influenced by the government bond market.

But first, let's take a look at how rates are set.

Does the Bank of Canada set all interest rates?

Not quite. The Bank of Canada (BoC) sets the 'target' for the overnight lending rate, which is the interest rate that banks charge each other to cover their short-term daily transactions. The 'target' overnight rate also influences what banks set as their prime lending rate.

The prime rate is what banks charge their most creditworthy customers. So, from the BoC's target rate, rates are set by banks in cascading effect down the chain.

When the BoC changes its target overnight rate, it's sending a signal to the banks that it wants them to change their prime rates. Banks sell floating-rate products, including variable-rate mortgages and lines of credit (such as HELOCs) that are tied to the prime rate, and move up and down in lock step with any changes.

But fixed mortgage rates aren't set by the prime rate. Instead, fixed rates are influenced by the government bond market.

Banks rely on bond yields to finance the expenses of holding these mortgages. Bond interest rates (bond yields) move up or down more frequently than the prime rate, because the bond market is far more sensitive to market fluctuations. Banks will (usually) move fixed mortgage rates when traders believe the BoC is about to increase, or reduce, bond interest rates.

What happens when rates go up?

When interest rates increase, it costs more to borrow money. If you're in the market for a house, higher rates will impact how much you'll pay each month for your mortgage, or how much house you'll be able to afford.

For example, if you need a $200,000 mortgage, at 5% interest, your monthly payment would be $1,163.21 (for interest and principal) for 25 years (your amortization).

But if your mortgage rate was 1% higher, at 6%, your mortgage payments would be $1,279.62 per month. Bump the rate to 7% and your payments are now over $1,400 a month. So, when interest rates go up, the trend is to save your money and spend less, especially on big purchases, such as a home or property.

The BoC moves to raise rates when it believes the economy is in danger of growing too rapidly or to spur volatile conditions, such as flaring inflation. For example, rapid economic growth could cause a cycle of rising prices and wages and contribute to inflationary pressures, which in turn may cause rates to be raised even higher in order to put the brakes on an 'unnatural' state of supply and demand.

So, the BoC seeks to moderate growth and volatility in order to keep multiple economic factors in check.

What happens when rates go down?

The simple answer is, of course, that the cost of borrowing goes down. Buying a home or property with a mortgage becomes more inviting, because lower interest rates mean lower monthly payments or more house that you'll be able to afford.

But, there's a catch. Lower rates are an unmistakable signal from the government's central bank that the economy is slowing down (job losses? wage cuts?) and people aren't buying enough big-ticket items. Lowering rates helps to spur economic growth because it makes it more attractive for businesses and consumers to borrow.

The caution comes with the potential to inject too much stimulus into the economy, which again would risk igniting inflation and rising rates. Correctly forecasting the balance of risks between stimulating or cooling our economy is the central bank's most difficult and most important task.

When are interest rates set in Canada?

The Bank of Canada sets their target rate eight times a year: in late January, early March, mid-April, late May, mid-July, early September, mid-October and early December.

They may take action between these fixed dates, but only under extraordinary circumstances.

The U.S. Federal Reserve also sets rates eight times a year. The Bank of England sets rates 12 times a year.

Where are rates going now?

In early March, the Bank of Canada (BoC) has raised its overnight lending rate for the first time since pandemic onset, from the 'emergency' low of 0.25% up to 0.50% (by 25 basis points; there are 100 basis points in a percentage point). Affecting anything tied to variable rates (i.e. some mortgages, and lines of credits), this increase comes after economic experts have clamoured for higher interest rates to help push down record-highs in both inflation and house prices.

As our Canadian economy recovers from pandemic upheaval, supply crunches and revolving crises have placed even more pressure on our economy. Many experts see the BoC continuing to hike rates at most announcements this year at least, with mentions of reaching towards a 'neutral' rate of 1.75-2.0%, (intended to neither spur nor dampen the economy at that rate). Will world events intervene in rate policy, or will inflation cause more economic kick-back than expected?

Only time will tell. In the meantime, talk to us if you have any questions about where rates are going or how your mortgage payments may be affected.

Related: Should you choose a variable or fixed mortgage rate?

Right now, rates are still low. But, inflation risks and economic pressures may see these rates continuing to rise in the near future.

The federal government has recently added new restrictions to mortgage stress-test rules to help ensure that Canadian home buyers will be able to afford their mortgage if rates go up.

We can hold your best rate for up to 120 days.

At True North Mortgage, we offer the best qualifying rates (thanks to our volume discount) and great mortgage advice. Our unified, salaried mortgage brokers are highly-trained help you sort out your options, and which rates or mortgage products will be the best for your situation.

Check out our current great rates here. Then, give us a shout — online, over the phone or at one of our store locations. Anywhere you are in Canada, we're here for you.

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