A lot. I suppose you are looking for more of an answer than that, so I will endeavor to provide some practical advice on how REALTORS® should think about rate announcements which happen eight times a year. Although I am not, nor have ever been a licensed mortgage broker I have been a REALTOR® and think some clarification from that perspective may be helpful…however, if you are looking for mortgage advice you are in the wrong place!
Overnight Overview
In Canada, we have a federal bank known as the Bank of Canada which is a corporation of the crown. You and I don’t have a bank card for the Bank of Canada since it is not a retail bank, but rather a bank for the banks in a way. During the day, financial institutions move money between themselves for their customers in countless transactions, and at the end of each day, they need to balance their books. Due to the sheer quantity of transactions, this requires them to borrow the shortfall at interest overnight from the other banks or borrow money from the Bank of Canada overnight. This interest rate is referred to as the overnight rate, or policy interest rate and this overnight rate becomes the benchmark for banks when determining their own markup on that rate for loans and interest on deposits.
Mortgage Markup
Now that we have a basic understanding of the overnight rate which is regularly referred to in the media after each rate policy announcement, it should be clear that the rate announced is not available to the borrower at a retail level. For example, if the Bank of Canada’s overnight rate is 2.5%, your local bank marks this rate up to a level acceptable to their business model and customers and that rate is called the prime rate. A derivative of the prime rate is a common benchmark the bank uses in the offering of variable rate mortgages, where they take the prime rate and either add or subtract a percentage from the prime rate based on the quality of the borrower or current lending environment such as Prime minus 0.5% or Prime plus 0.25%. The variable rate then floats with the prime rate, meaning that the rate offered to the borrower at the start of the mortgage term will move by the same percentage the prime rate moves.
Fixed Rate Frustration
Sometimes when the bank of Canada lowers the overnight rate, fixed-rate mortgage customers are frustrated because the fixed mortgage rates don’t drop also. This is seen as just banks trying to keep more profits for themselves, and although banks are not allergic to higher profits, there is a more concrete reason for the fixed rates to change in different cadence to the prime rate. In short, the fixed-rate mortgages are tied to government bond yields and not to the overnight rate directly. Without getting too complicated, imagine the bank has money to invest (I know it is hard to imagine), and they need to choose between investing in a government bond, or a mortgage for Mr. and Mrs. Joe Q. Public. The government bond is guaranteed to provide a fixed, albeit low, rate of return for the term of the bond, however, lending on a mortgage bears more risk and expense but the potential of a higher rate of return. So essentially what happens is the bank makes a calculation to determine what that additional risk is worth in percentage and adds that to the current return rate on bonds of the same term to make it more worthwhile to invest in the mortgage. Because of this calculation, when the bond yields change, the calculation changes, and subsequently the fixed mortgage rate for that term changes too. The overnight rate does affect the Canadian economy generally of course, which indirectly affects bond yields over time but there is no real direct correlation in near-term lending.
What Real Estate Clients Need To Know
There are a couple of wise takeaways from the understanding of mortgage rate changes. First, the mortgage rates will change. I know, it is earth-shattering truth, but sometimes this is the best advice to provide a consumer to get them to meet a licensed mortgage broker and lock a rate in when planning to purchase a home. Sometimes rates rise and sometimes they fall, but clients need professional mortgage advice to know the best path forward for them. Second, don’t believe everything you hear. When you hear on the news that the Bank of Canada is expected to raise rates, or that fixed mortgage rates are on the rise, that may be true, but it may not affect your situation specifically, or at least not in the panicked way it is often portrayed. Take a breath and call a REALTOR® or a licensed mortgage broker.
Finally, for those out there with an existing mortgage on your home, remember that in general, the interest rate on your mortgage is some of the lowest cost borrowing you can do. Here is a triple-benefit you get as a bonus to help with your news-cycle anxiety:
- You get to live in your investment and enjoy it.
- Every mortgage payment you make adds to the equity position in your home, kind of like paying rent to yourself.
- Over time the value of your investment grows in the form of appreciative growth, so just by living there, the value is increasing.
For those who are not yet homeowners, ignore the fear, call a REALTOR®, and buy a home!