My Articles > How Mortgage Rates Are Set in Canada
There is without a doubt a lot of confusion about how the mortgage rates are set in Canada. Every time we hear the announcement that the Canadian prime rate is going up we automatically tend to think that the mortgage rates will go up as well. Well, the reality is that while variable mortgage rates do fluctuate with the prime rate, this is not the case with fixed mortgage rates, at least not significantly.
Let's first take a look at the variable mortgage rates. Most variable rates in Canada are directly tied to the prime rate. You have probably heard of "prime less 0.9%" or "prime minus 0.25%" mortgage rates, and many of us probably have or had some type of a variable mortgage rate. The way these mortgage rates change is very simple. As Bank of Canada increases or decreases the prime rate, variable rates get automatically adjusted accordingly. For example, if the prime is 7% and you have a prime minus 0.5% variable mortgage, your rate would be 6.5%. It is not hard to conclude that if the prime goes up by 0.25%, your rate would automatically go up to 6.75%.
Alternatively, fixed mortgage rates are based on yields in the bond market. The yield can be described as an annual rate of return on an investment, expressed as a percentage. When banks are deciding where to invest their money they always have the option of investing them in a Government of Canada bond, which represents a risk-free investment for them. So, when banks decide to invest into mortgages, they would simply take the ongoing yield in the market, add their expenses and the profit margin, and come up with a fixed mortgage rate.
The bond yields are determined by investors' expectations about where the interest rates will be in the future. If the investors believe that the long term interest rates are going to go up, this would put a pressure on the bond yields and could cause them to increase, hence affecting the fixed mortgage rates. This is why fixed mortgage rates could get slightly affected when there is an announcement about the change in the prime rate. If the prime is expected to go up, investors might perceive that the long term rates will go up as well, affecting therefore the bond yields.
To support the fact that the fixed rates are not automatically affected by the change in the prime rate it can be said that there were several instances where prime rate and fixed mortgage rates have moved in the opposite directions. It is not uncommon, therefore, to see mortgage rates increasing while prime rate decreases, and vice versa.
If you are interested in predicting where the fixed mortgage rates are going, you should track Government of Canada bond yields on a regular basis. You can find the updated bond yields in financial sections of your local newspapers. If you see a continuous trend upwards or downwards, this could be an indication that the fixed mortgage rates might soon be changing.
