If you’re shopping for a mortgage, you’ve picked a perfect time! Five-year, fixed-rate mortgages, the most popular mortgage options among Canadians, are at their lowest levels in two years.
Mortgage rates have been low for quite some time, but have you ever stopped to wonder why? “It’s the economy, of course” is what you’re probably thinking, and that does have something to do with it. But, there are other factors at play.
There are two main types of mortgage rates in Canada – fixed and variable – and different factors influence them. In this article, we’ll discuss all of these and look at the strong connection between mortgage rates and the real estate market.
A fixed-rate mortgage is when your rate stays the same for the duration of your mortgage term. For example, if you have a five-year, fixed-rate mortgage, your rate is set for five years. This is often referred to as “locking in” your rate. That’s because not only does your mortgage rate stay the same for the length of the note, but your mortgage payment stays the same, as well.
If you’re a first-time homebuyer who’s looking for some peace of mind, a fixed rate may be the way to go. Knowing exactly what your mortgage payment will be in the coming years makes it a lot easier to budget. Just keep in mind that there’s no such thing as a free lunch, especially when it comes to mortgage rates. In many cases, you’ll pay a premium for locking in. Usually, longer, fixed terms mean you’ll pay higher rates.
What Affects Fixed-Rate Mortgages?
Government of Canada bond yields have a direct influence on fixed-rate mortgages. Furthermore, the bond yields that match the terms of fixed-rate mortgages are tied together even more closely. For instance, five-year Government of Canada bond yields are closely linked to five-year, fixed-rate mortgages.
However, mortgage rates and Government of Canada bond yields don’t match up perfectly. Mortgage lenders need to make a profit to stay in business, so they charge a spread – or premium – on top of Government of Canada bond yields. The spread of each lender is dependent upon several factors, including competition, overhead expenses and profit goals. But, generally speaking, lenders aim for a 1% spread on insured mortgages, which is when the borrower puts down less than 20% on a property; lenders target a 1.5% spread on conventional mortgages, when the borrower puts down at least 20%. For example, if Government of Canada bond yields are 1.5 %, a lender might offer insured mortgages at 2.5% and conventional mortgages at 3%.
However, not all lenders have the same mortgage rates, and Government of Canada bond yields are just one influencer upon them. Competition also plays a role in mortgage rates. Each year, there seems to be a mortgage rate war, and this spring was no exception. Some lenders were willing to take a hit to their bottom lines in order to be a market leader in mortgage rates; others were competitive without being market leaders, instead relying on the strength of their brands.
The time of year also has an effect on lenders’ competition in mortgage rates. Typically, lenders are most competitive during the spring real estate market, and rightfully so: that’s when the majority of mortgages are usually funded in the year. However, when the spring market passes, lenders tend to be less competitive. During the fall and leading up to the holiday season, they widen the spread to 2% or greater. This happens for a couple of reasons: mortgage volume declines at this time of year, and the approaching year-end means lenders tend to be focused on boosting their bottom lines.
A variable-rate mortgage is when your rate can change during your mortgage term. For example, if you have a five-year, variable-rate mortgage, your rate could change at any point within those five years. However, this typically only happens when the Bank of Canada adjusts interest rates. Your variable rate is based upon your lender’s prime rate, sometimes referred to as just “prime.” This is the rate lenders offer to their most creditworthy customers – plus or minus a spread. For example, if you had a variable rate of prime minus 70 basis points (.7%) and the prime rate was 3.95%, then your mortgage rate would be 3.25%.
The spread between your mortgage rate and the prime rate is key. Although your mortgage rate isn’t locked, the spread is. For that reason, you want to get as wide of a spread as possible when you have a variable rate. It’s also important to read the fine print when you sign. Interest rates may be low now, but they likely won’t be this low forever. Five years is a long time, and if interest rates rise, you need to know how they will affect your mortgage payments. Depending on the lender, your mortgage payments may go up or stay the same, but more of your money will go toward interest and less toward principal. Knowing this information ahead of time could help you prepare in the event that your rate were to go up during your mortgage term.
What Affects Variable-Rate Mortgages?
While fixed-rate mortgages are influenced by Government of Canada bond yields, variable-rate mortgages are determined by interest rates set by the Bank of Canada. When the Bank of Canada changes interest rates, mortgage lenders almost always follow in lockstep. Using the example from earlier, let’s say your mortgage rate is at 3.25% and the Bank of Canada raised interest rates by 25 basis points (.25%). If your lender raised its prime rate from 3.95% to 4.2%, your mortgage rate would increase from 3.25% to 3.5%.
Competition also influences variable-rate mortgages. As previously mentioned, lenders tend to offer their most generous spreads of the year in the spring. Some even offer variable-rate mortgages with terms of less than five years with even lower rates to drum up business.
Note that the prime rate has remained consistent throughout 2019 thus far, but there’s no guarantee it won’t change in the future. If the thought of saving money sounds interesting, then a variable rate is worth considering. But, if the possibility of rates going up during your mortgage term keeps you up at night, you might consider the safety and security of a fixed-rate mortgage.
The Connection Between Mortgage Rates & Real Estate
Finally, there is a strong connection between mortgage rates and the real estate market. It’s probably not a surprise that low mortgage rates stimulate the real estate market. When rates are low, money is cheap to borrow. That means that you can qualify to borrow more money and, conversely, spend more on a home.
But, low mortgage rates can also drive up home prices faster than normal. Because homebuyers can borrow more money, they’re willing to spend more on properties, which means that a home is more likely to sell for more than it otherwise would – if mortgage rates were higher.
Now you know what to consider the next time you’re ready to make an offer on a property. Be sure to always talk to you real estate agent and see what are the best options available for you.
This article is intended for informational purposes only and should not be deemed as legal, financial or investment advice or solicitation of any kind. Before purchasing real estate or insurance, always consult with a licensed attorney, financial advisor, insurance agent and real estate broker.
This is a guest post by Sean Cooper, the bestselling author of the book, Burn Your Mortgage: The Simple, Powerful Path to Financial Freedom for Canadians. He bought his first house when he was only 27 in Toronto and paid off his mortgage in just 3 years by age 30. An in-demand Personal Finance Journalist, Money Coach and Speaker, his articles and blogs have been featured in publications such as the Toronto Star, Globe and Mail, Financial Post and MoneySense. Connect with Sean on LinkedIn, Twitter, Facebook and Instagram.