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).

Let's pull back the curtain — what wizardry is behind mortgage rates?

Are mortgage interest rates going up? Going down? Staying put? It can be an all-consuming obsession (well, it is for us!). Rates can substantially impact Canadian home buyers — in getting a mortgage, affording a mortgage, paying off a mortgage ... you get the idea. Even a quarter of a percentage either way 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? 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 directly tied to lender prime rates, which in turn are directly affected by the Bank of Canada's (BoC's) benchmark rate.

Fixed rates are mainly influenced by Bank of Canada bond yields and changes in the bond market.

How does the Bank of Canada influence variable mortgage rates?

The Bank of Canada (BoC) sets the 'target' for the overnight lending rate, which is the interest rate banks charge each other to cover their short-term daily transactions. In turn, this 'guiding' policy rate influences what banks charge their best customers — called the 'prime rate.'

When the BoC changes its target overnight rate, it signals to the banks that it wants them to change their prime rates — which they usually do (but not always), passing on increases or decreases directly to their customers.

Banks offer many prime rate products with 'floating' interest rates, such as variable rate mortgages and lines of credit (such as HELOCs).

How do Bank of Canada bond yields influence fixed rates?

Banks use traded annual bond returns — referred to as bond yields — to set their fixed mortgage rates. Both are sources of capital for banks and compete on similar terms, coming with 'fixed' interest payments that pin the framework for comparison and competition.

But bonds are considered a safer, more 'low-maintenance' investment, while fixed-rate mortgages come with more risk and cost for a 'higher-maintenance' investment. That's why fixed mortgage rates are usually set at 1-2% higher than current bond yields, a spread relationship that can be pushed higher or lower as the bond market (which can change daily) also goes up or down as it anticipates policy and market-condition changes.

How are variable rates set?

Variable mortgage rates are set from lender prime rates, and 'float' along with any prime rate changes.

However, lenders will often offer their 5-year variable rate (to their best clients) at a 'discount off of prime' to compete with other lenders. Lender discounts are each based on their mortgage-lending bottom lines and what the market will bear to attract business. The variable rate you sign up for includes your lender discount, which stays constant for your full 5-year term, even though the rate itself may change.

How are fixed rates set?

Fixed mortgage rates are set according to the bond yield market trends, and set higher than bond yields at a (typical) spread relationship of 1-2%.

The 5-year fixed rate mortgage is the standard term that banks compete on, and so watching 5-year bond yields offer a good indication of where fixed rates may be going.

  • When 5-year bond yields are up, it usually means fixed rates will follow if the trend continues.
  • When 5-year bond yields are down, it usually means fixed rates will lower, though banks will react more slowly to decrease their rates.
  • Bonds trade daily, so the 5-year mortgage rates can move at any time.
  • Mortgage rates don't move lockstep with bond yields but have a spread-relationship that can help determine where rates may be headed.

When you sign up for a fixed rate, it's yours for your full term and won't change until it's time to renew.

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 monthly payments are now over $1,400. 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.

Why do rates go up? The BoC moves to raise its benchmark rate when it believes the economy is in danger of too-rapid growth or to spur volatile conditions, such as flaring inflation. For example, surging economic growth could cause a cycle of rising prices and wages and contribute to inflationary pressures, which may cause rates to go even higher to put the brakes on an 'unnatural' state of supply and demand.

So, the BoC aims to moderate growth and volatility 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. When rates are being lowered, it can help spur economic growth by making 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.

How often does the BoC set (variable) rates in Canada?

Affecting lender's prime rates and, therefore, your variable rate mortgage products, the Bank of Canada schedules eight 'interest rate announcement' dates each year:

  • Late January
  • Early March
  • Mid-April
  • Late May/Early June
  • Mid-July
  • Early September
  • Mid-October
  • Early December

At these dates, the central bank will either move their benchmark rate or keep it the same — while (strongly) commenting on economic conditions and influences to outline their rate sentiment and future direction.

They may take action between these scheduled times, 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.

What is a mortgage stress-test rate?

Regardless of the actual mortgage rate you receive from your lender, you'll need to qualify at a higher rate determined by the federal government (right now, it's 2.0% higher than your contract rate). This requirement was set in place in 2019 to help ensure Canadian homeowners can still afford their payments if rates go up.

Read more about how the latest stress-test rules may affect your home affordability.

Thinking about which rate to set?

Hold your best rate for up to 4 months while you mull it over.

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 to help you sort out your options, and which rates or mortgage products will be the best for your situation.

Holding your best rate for as long as the lender will allow (can be up to 4 months) will protect you against increases while you make home buying or mortgage decisions.

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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Get your best rate, with a better mortgage fit.