You’ve likely noticed that fixed mortgage rates don’t always move in sync with the Bank of Canada’s announcements. Fixed rates do however move with the bond markets.
To understand why fixed mortgage rates go up or down, it helps to understand bonds. A simplified way to think of bonds is to think of them as the “wholesale cost of money” for banks. When you take out a fixed rate mortgage, the bank is essentially “buying” that money from the market. The price the bank pays for the money is dictated by the bond market.
1. Bond Yield.
A bond is a loan made by an investor to a borrower (typically the government). The yield is the annual return an investor gets for holding that bond.
A crucial rule in finance is that bond prices and yields move like a teeter-totter:
- When bond prices go up, yields go down and fixed rates go down.
- When bond prices go down, yields go up and fixed rates go up.
2. The Link Between Bonds and Your Mortgage
Banks don’t just use the money in your savings account to fund fixed-rate mortgages. To manage their risk, they look at the return or spread they could get by simply buying a “risk-free” government bond instead of lending to a person.
The “Spread” (The Bank’s Cut)
Banks never charge you the exact same rate as the bond yield. They add a “spread” (usually 1.0% to 2.0%) to cover:
- Operating Costs: Managing the loan.
- Risk: The chance a borrower might default.
- Profit: The bank’s margin.
3. How This Affects You in Real Life
When investors see signs of high inflation or expect the central bank to raise rates, they often sell off bonds. This causes bond prices to drop and yields to spike.
Pro Tip: Lenders are often “quick to rise, slow to fall.” When yields go up, banks usually hike rates within days. When yields drop, they often wait a few weeks to ensure the trend is permanent before passing the savings to you.
4. Fixed vs. Variable/Adjustable: A Key Difference
It is a common misconception that the Bank of Canada’s “Policy Rate” sets all mortgage rates.
- Variable/Adjustable Rates are tied directly to the lender’s Prime Rate, which is directly influenced by the Bank of Canada’s Policy Rate.
- Fixed Rates are tied to the Bond Market.
This is why you might see fixed rates falling even while the Bank of Canada is holding rates steady—it means the bond market expects rates to be lower in the future.
