How Government Bond Yields Relate To Mortgage Rates

Linked together through investment risk, learn how bonds affect your mortgage rate.

Updated April 2022

Government bonds and mortgage rates. What's the connection?

Many people don't realize the strong correlation between fixed mortgage rates and Bank of Canada bond yields.

Both rates can change daily, but each carries different risks — at relatively opposite ends of the spectrum. Fixed mortgages are considered 'riskier' assets for banks, while government bonds are thought of as 'safer,' or even risk-free. Why?

Government bonds are 100% guaranteed to be repaid, but mortgages are not. Mortgages carry more risk of default or early repayment, which could potentially disturb the expected return on investment. Mortgage rates, therefore, are priced higher by banks to compensate for that added risk.

Many factors can affect fixed mortgage rates. But the single biggest factor is Government of Canada bond yields. Banks actually use the 5-year bond yield market to determine their fixed mortgage rates, using the forecasted earnings from bond investments to cover the costs and possible losses incurred through their mortgage market.

Related: How are mortgage rates set?

How much higher are mortgage rates priced over bond rates?

As the 5-year bond yield rises, lenders get squeezed by the rise in funding costs. At some point, they can no longer absorb the increase and will pass it on to the borrower by raising their fixed mortgage rates (variable rates aren't as affected, as they're tied to the prime rate).

In a normal market, the average 'spread' or markup of fixed mortgage rates above secured government bonds is roughly 100 to 200 basis points, or 1% to 2% (there are 100 basis points in a percentage point). That markup — the spread relationship — will widen and contract in response to a range of market conditions, such as the risk of rising inflation, investor appetites, product supply, and competition from other investment opportunities, like corporate bonds or equity markets.

During times of financial uncertainty, this spread can widen. For example, during 2020, as the Canadian markets were tossed around by the COVID-19 pandemic, some mortgages rates were briefly raised even though bond yields fell.

It's not automatic that banks will raise fixed mortgage rates as soon as bond yields increase. But with economic conditions trying to sketch out a recovery, and housing markets trying to cool off, if bond yields increase, fixed rates are likely to follow.

What's going on with bond yields right now?

Update September 23, 2021: Increases in Canadian bond yields are suddenly afoot, after the past few weeks of a downward trend.

With more hawkish tones recently emanating from the U.S. and other global banks (as they closely watch the pandemic economic fallout and China's Evergrande debt handling) — the 10-year benchmark bond yield suddenly topped up to 1.33%, with 5-year yields up to 1.03%.

After the 5-year bond yield hit record lows in 2020 (down to 0.3% at one point), and a slow recovery in the first-half of 2021 to around 0.90%, this latest sharp increase have experts wondering if the lowering of 5-year fixed mortgage rates last week by Canadian lenders was premature.

And, because rising bond yields often lead to a rise in fixed mortgage rates, there's already wide speculation that Canadian lenders will increase their rates in line with the latest bond yield activity.

Update November 1, 2021: As predicted, bond yields are continuing their climb and fixed rates are following. At a 21 month high, the 5-year bond yield is up to 1.5%. Several lenders increased their fixed rates again last week, following the Bank of Canada's announcement that officially ended their pandemic stimulus program (check out our current rates here).

There are still many volatile factors that may affect rates and investments this year and next, including the impact on bond yields, rising inflation, and labour and housing shortages — so we wait, and watch.

Updated April 13, 2022: With surging, persistent inflation, higher home prices and an economy showing signs of roaring back to pre-pandemic levels, the government has flipped the script to begin quantitative tightening. In the first quarter of 2022, the 5-year bond yield has shot up to sit at 2.50% currently. The recent rise has brought several increases to the fixed mortgage rate market, increasing the spread between variable and fixed rates even wider.

What should you do about a potential rise in mortgage rates?

With fixed mortgage rates on the rise, apply now or connect with one of our highly-trained True North Mortgage specialists. We can provide perspective on market changes, plus hold your best rate now for up to 120 days, to protect you from any more changes over the next few months.

We'll also help you assess the latest federal mortgage stress-test regulations and their impact on your qualifying rate and mortgage affordability.

Check out our latest volume-discount mortgage rates here. And check back for updates as we watch where bond yields and fixed-mortgage rates may be headed.

Whether you decide to lock in for a longer term, or protect your current rate through a pre-approval — we're here to save you time, money and stress.

Lock in your best rate, now.