Understanding Mortgage Rates: A Homeowner’s Guide

Ever wonder why mortgage rates change and how they’re determined? Let’s break down the complex world of mortgage rates into simple, digestible pieces that will help you make informed decisions about your mortgage.

The Building Blocks: Key Interest Rates

Think of Canada’s interest rate system like a multi-story building:

• The foundation is the Bank of Canada’s overnight rate
• The ground floor is the banks’ prime rate
• The upper floors are the actual mortgage rates you’ll be offered

The Foundation: Overnight Rate

This is the Bank of Canada’s baseline rate – think of it as the wholesale price of money. It’s the rate banks use when lending money to each other for very short periods (overnight, hence the name).

The Ground Floor: Prime Rate

The prime rate sits about 2.20 percentage points above the overnight rate. While each bank technically sets its own prime rate, they move in lockstep – when one bank changes its rate, others typically follow within hours.

Real World Example:

• Current overnight rate: 3.25% (as of January 2025)
• Current prime rate: 5.45%
• The difference (2.20%) is called the “spread”

Note: The next Bank of Canada rate announcement is scheduled in 8 days – this could affect these rates.

Think of this spread like a store’s markup on wholesale products – it helps cover the bank’s costs and profits.

Variable vs. Fixed Rates: Two Different Stories

Variable Rate Mortgages: Following Prime

Variable rates are like being on an escalator – they move up or down with the prime rate. They’re usually expressed as “prime plus/minus X%”

Example Scenarios:

• “Prime – 1%” = 4.45% (based on current 5.45% prime)
• “Prime + 0.5%” = 5.95%

If you choose a variable rate, you’ll need to watch Bank of Canada announcements. These happen eight times per year and can affect your mortgage payments within days.

Fixed Rate Mortgages: Following Bonds

Fixed rates are more like taking the stairs – they’re stable once you’re on them, but the next set of stairs might be higher or lower when your term ends.

Fixed rates follow Government of Canada bond yields:

• 5-year fixed mortgages follow 5-year bond yields
• 3-year fixed follows 3-year bonds And so on…

Example: If the 5-year government bond yield is 3.5%, banks might offer 5-year fixed mortgages at around 5.5% (a 2% spread).

Understanding Spreads: The Bank’s Cushion

Think of spreads like shock absorbers in a car – they help smooth out the bumps in the financial road. Banks use these spreads to:

• Cover their operating costs
• Protect against potential loan defaults
• Maintain profit margins
• Handle unexpected market changes

Positive vs. Negative Spreads

Most of the time, banks maintain positive spreads (they charge more than their cost of funds). However, sometimes you might see what appears to be a negative spread, like an ultra-low promotional rate. Banks do this to:

• Attract new customers
• Build market share
• Sell other profitable products (like credit cards or investments)

What This Means for Your Mortgage

If You Choose a Variable Rate:

• Watch Bank of Canada announcements
• Understand your tolerance for payment changes
• Know your conversion options to fixed rates

If You Choose a Fixed Rate:

• Monitor bond yields when approaching renewal
• Understand rate hold periods
• Consider the timing of your purchase or renewal

Market Monitoring Tips

For Variable Rates:

• Mark Bank of Canada meeting dates on your calendar
• Watch for prime rate announcements from major banks
• Follow economic news that might influence Bank of Canada decisions

For Fixed Rates:

• Track Government of Canada bond yields
• Watch for changes in bank fixed rate offerings
• Monitor economic indicators that affect bond markets

The Bottom Line

Understanding these relationships helps you:

• Make informed decisions about rate choices
• Anticipate rate changes
• Understand market movements
• Time your purchase or renewal more effectively

Remember: While variable rates offer transparency (they move with prime), fixed rates provide certainty (they’re stable for the term). Neither is inherently better – it depends on your specific situation, risk tolerance, and financial goals.

---

Note: All rates mentioned in examples are for illustration purposes and may not reflect current market rates and should not be entirely relied upon to make decisions. Always verify current rates with lenders.

– Kai T.