Understanding Mortgage Rates in Canada

For Canadians looking to buy a home, understanding how mortgage rates are determined can make a significant difference in financial planning. Mortgage rates influence monthly payments, overall interest costs, and affordability. Whether you’re a first-time homebuyer or refinancing your mortgage, knowing what factors impact rates can help you secure the best deal.

In this guide, we’ll break down how mortgage rates are calculated in Canada, the factors that influence them, and tips for getting the best rate.

What Determines Mortgage Rates in Canada?

Mortgage rates in Canada are influenced by multiple economic and financial factors, including the following:

1 – The Bank of Canada’s Policy Interest Rate

The Bank of Canada (BoC) sets the benchmark interest rate, also known as the overnight lending rate. This rate directly affects how much it costs financial institutions to borrow money, which in turn impacts the mortgage rates offered to consumers.

When the BoC raises its key rate, mortgage rates typically increase, making borrowing more expensive. Conversely, when the BoC lowers its rate, mortgage rates tend to decrease, making homeownership more affordable.

2 – Government Bond Yields

Fixed mortgage rates are heavily influenced by government bond yields, particularly the 5-year bond yield. Lenders use these yields to determine the cost of long-term borrowing. As bond yields rise, fixed mortgage rates typically increase, and when bond yields fall, mortgage rates tend to drop.

3 – Lender-Specific Considerations

Each lender determines mortgage rates based on their operational costs, risk tolerance, and profit margins. Some lenders may offer lower rates to attract customers, while others may adjust rates based on their internal financial models.

4 – Credit Score & Borrower Profile

Your individual credit profile plays a key role in determining the rate you receive. A high credit score (typically 700 and above) can help you qualify for lower mortgage rates, while a lower score may result in higher interest rates due to the perceived lending risk.

5 – Mortgage Type: Fixed vs. Variable

The type of mortgage you choose affects the rate you pay:

• Fixed-Rate Mortgages: The rate remains constant throughout the loan term, providing predictable payments.
• Variable-Rate Mortgages: The rate fluctuates based on the lender’s prime rate, which is influenced by the Bank of Canada’s policy rate.

How Fixed vs. Variable Mortgage Rates Are Calculated

Fixed Mortgage Rates

Fixed mortgage rates are closely tied to government bond yields. Lenders use the 5-year bond yield as a benchmark and add a spread (profit margin) to determine their fixed rates.

For example:

• If the 5-year government bond yield is 3.00% and the lender adds a 1.5% spread, the fixed mortgage rate offered might be 4.50%.

Variable Mortgage Rates

Variable mortgage rates are linked to the lender’s prime rate, which fluctuates based on the Bank of Canada’s interest rate decisions.

For example:

• If the prime rate is 6.00% and a lender offers a discount of 0.50%, your mortgage rate would be 5.50%.

Additional Factors That Influence Mortgage Rates

Loan-to-Value (LTV) Ratio

The LTV ratio compares the mortgage amount to the property’s value. If you have a lower LTV (meaning a larger down payment), you may qualify for a better rate since the lender assumes less risk.

Amortization Period

A shorter amortization period (e.g., 20 years instead of 30 years) can result in a lower interest rate. However, it also means higher monthly payments.

Mortgage Term Length

The term length (e.g., 1, 3, 5, or 10 years) affects the rate offered. Generally, shorter-term mortgages have lower interest rates than longer-term ones.

Open vs. Closed Mortgages

• Closed Mortgages: Offer lower rates but have prepayment restrictions.
• Open Mortgages: Allow full repayment anytime but typically come with higher rates.

How to Secure the Best Mortgage Rate in Canada

1 – Improve Your Credit Score

• Pay bills on time and reduce outstanding debts.
• Avoid multiple hard credit inquiries before applying for a mortgage.

2 – Save for a Larger Down Payment

• A down payment of 20% or more reduces your LTV ratio and helps you qualify for better rates.

3 – Compare Lenders and Mortgage Products

• Different lenders offer different rates and incentives. Consider mortgage brokers who can provide multiple options.

4 – Consider Rate Holds and Pre-approvals

• A rate hold locks in a mortgage rate for 60-120 days, protecting you from increases.

5 – Choose Between Fixed and Variable Rates Wisely

• If interest rates are expected to rise, a fixed rate may be more stable.
• If rates are expected to fall, a variable rate could save you money.

Case Study: Fixed vs. Variable Mortgage Rate Impact

Scenario: A buyer is purchasing a $500,000 home with a 20% down payment.

• Fixed Rate Option: 5-year term at 5.00%.
• Variable Rate Option: Prime -0.50% (5.50% at the start, but fluctuates).

If interest rates increase, the fixed-rate borrower maintains a predictable payment, while the variable-rate borrower may face higher costs over time.

Conversely, if rates drop, the variable-rate borrower could save money.

Legal and Tax Considerations

Mortgage Interest Deductibility

• In Canada, mortgage interest is generally not tax-deductible for primary residences but may be for rental properties.

CMHC Insurance Requirements

• If your down payment is less than 20%, you must purchase mortgage default insurance through the Canada Mortgage and Housing Corporation (CMHC), which affects your total borrowing cost.

Conclusion

Mortgage rates in Canada are influenced by various economic factors, including the Bank of Canada’s policy rate, government bond yields, and individual lender policies. Understanding how these factors interact can help borrowers make informed decisions and secure the best mortgage rate.

By improving your credit score, saving for a larger down payment, and comparing lenders, you can optimize your mortgage strategy and potentially save thousands over the life of your loan.

For personalized mortgage advice, reach out to Concourse Mortgage Group in Calgary, Alberta.