How Are Mortgage Rates Determined and What You Can Do

Mortgage rates can be a mystery to many, but understanding how they're determined can help you make informed decisions about your home loan.

Mortgage rates are influenced by the economy, with changes in inflation and unemployment rates affecting the overall interest rate environment.

To get the best mortgage rate, you need to have a good credit score, which can save you thousands of dollars over the life of the loan.

A credit score of 760 or higher can qualify you for the best mortgage rates, according to the Federal Reserve.

Mortgage rates are primarily determined by the Bank of Canada's (BoC) policy rate.

The BoC sets the target overnight rate, known as the policy rate, to keep inflation in check at 2% and preserve the value of the Canadian dollar. This rate is expected to be used as the benchmark that influences the rates that banks, lenders, and financial institutions set for their variable lending products.

Variable-rate mortgages are adjusted based on the lender's prime rate, which is set against the BoC policy rate plus a spread, usually 2.2%. This means that when the policy rate changes, prime rates will change accordingly, and variable mortgage rates will adjust accordingly.

Fixed-rate mortgages, on the other hand, follow trends in bond yields with similar term lengths. If the current 5-year bond yield is 4%, you can expect that 5-year fixed mortgage rates would be in the 5% to 6% range.

Canada's economy, particularly inflation, is one of the most significant factors affecting mortgage rates. The Bank of Canada adjusts its policy rates to control inflation and bring it to the 2% target.

The Bank of Canada's policy rate influences prime rates, which are then used by lenders to set their posted rates. Most lenders determine the prime rate based on the policy rate plus 2.2%.

The Bank of Canada's target overnight rate, also known as the policy rate, is set to keep inflation in check. This rate is expected to be used as the benchmark that influences the rates that banks, lenders, and financial institutions set for their variable lending products.

Government bonds are traded in anticipation of Bank of Canada rate announcements. This means that bond yields are indirectly influenced by what the market expects will happen with the Bank of Canada's policy rate.

The Bank of Canada's policy rate adjustments will also indirectly affect fixed-rate mortgages, as bond yields are influenced by expectations of the policy rate.

The factors you control can significantly impact the mortgage rate you're offered. A good credit score is key, and borrowers with scores of 740 or higher get the lowest rates.

A credit score of 700 to 739 is still respectable, but you may not have as many loan options as those with a score of 740 or higher. Borrowers with scores from 620 to 699 may face higher interest rates and limited loan choices.

A bigger down payment is always a good idea, as it reduces your loan-to-value ratio and makes you a less risky borrower. A loan-to-value ratio of 80% or higher is considered high and may result in a higher mortgage rate.

Lenders view certain types of loans as riskier, such as cash-out refinances, adjustable-rate mortgages, and loans on manufactured homes or investment properties. These loans often come with higher interest rates and stricter terms.

The bond market plays a significant role in determining mortgage rates. Banks and investment firms market mortgage-backed securities (MBSs) as investment products, and the yields available from these debt securities must be sufficiently high to attract buyers.

The yields offered by MBSs are influenced by the yields available from competing long-term fixed-income investments, such as government and corporate bonds. The overall condition of the larger bond market indirectly affects how much lenders charge for mortgages.

Lenders have to generate sufficient yields for MBSs to make them competitive in the total debt security market. One frequently used government bond benchmark to which mortgage lenders often peg their interest rates is the 10-year Treasury bond yield.

Typically, MBS sellers must offer higher yields because repayment is not 100% guaranteed as it is with government bonds. This means that if the 10-year Treasury bond yield is 4%, you can expect that mortgage rates would be in the 5% to 6% range, as fixed-rate mortgages historically have been priced 1% – 2% higher than bond yields.

The Bank of Canada plays a crucial role in determining mortgage rates in Canada. It influences mortgage rates through its monetary policy, aiming to keep inflation at 2% to preserve the value of the Canadian dollar.

The Bank of Canada sets the target overnight rate, known as the policy rate, which serves as a benchmark for banks, lenders, and financial institutions to set their variable lending products. This rate is adjusted eight times a year, on specific dates, to control inflation.

Here are the dates when the Bank of Canada adjusts its policy rate in 2024:

The policy rate directly affects variable-rate mortgages, as lenders adjust their prime rates in line with changes to the policy rate, usually adding a 2.2% spread.

Variable mortgage rates are determined by the BoC policy rate, which influences prime rates. Prime rates are then used by lenders to set their posted rates, which are the rates lenders advertise.

The prime rate is calculated by adding 2.2% to the BoC policy rate. This means that if the policy rate increases, prime rates will also increase, and vice versa. For example, if the policy rate is 2%, the prime rate would be 4.2%.

Lenders then combine the prime rate with additional percentage points to determine the variable interest rate they will charge. This can be either a plus or minus, depending on the lender's policies.

The factors beyond your control can be a bit tricky to understand, but basically, the overall level of mortgage rates is set by market forces. This means that mortgage rates move up and down daily based on the current and expected rates of inflation, unemployment, and other economic indicators.

Mortgage rates tend to rise when the outlook is for fast economic growth, higher inflation, and a low unemployment rate. This is because lenders demand higher interest rates as compensation when prices go up.

Rising inflation is often accompanied by rising interest rates, because when prices go up, the dollar loses buying power. Low inflation over the past 10 years has contributed to low mortgage rates, with the 30-year fixed-rate mortgage lingering below 5% for most of the past decade.

The Federal Reserve doesn't set mortgage rates, despite its influence on the economy. Mortgage rates rise and fall according to the same economic forces that affect the Fed's short-term interest rates.

Mortgage investors pay close attention to many economic trends, including retail sales, home sales, housing starts, corporate earnings, and stock prices. These trends can all impact mortgage rates, often in subtle but significant ways.

The Federal Reserve plays a crucial role in determining interest rates, but it doesn't set specific mortgage rates directly.

The Fed's actions in establishing the Fed Funds rate and adjusting the money supply have a significant impact on interest rates available to borrowers. This is because increases in the money supply put downward pressure on rates, while tightening the money supply pushes rates upward.

The Fed's goal is to achieve maximum employment and maintain stable prices, which influences the economy and interest rates. By ensuring the financial system remains safe and sound, the Fed helps maintain economic stability.

The Fed's monetary policy is a key factor in influencing interest rates, including mortgage rates. Its actions can have a ripple effect on the economy, making it essential to understand how the Fed's decisions impact interest rates.

As the central bank of the United States, the Fed's actions have a significant impact on the economy and interest rates. By adjusting the money supply, the Fed can influence the overall demand for mortgages, which in turn affects mortgage rates.

Stress tests are set by the Office of the Superintendent of Financial Institutions (OSFI).

The OSFI sets mortgage stress test rates to assess whether you can continue to make mortgage payments if faced with financial challenges.

The stress test rule sets a minimum qualifying rate (MQR) of 5.25%, which is the "floor" set by OSFI.

This floor is set to account for risks to the borrower from economic fluctuations, such as changes in income or increasing mortgage rates.

The buffer set by OSFI at + 2% of your contract rate builds in a margin of safety to test whether borrowers can withstand changes to their financial circumstances.

Mortgage rates can be confusing, but understanding the different types can help you make informed decisions. There are three main types of mortgage rates: fixed, adjustable, and hybrid.

A fixed mortgage rate is a type of mortgage where the interest rate remains the same for the entire loan term, such as 15 or 30 years. This means your monthly payments will be the same every month.

Adjustable mortgage rates, on the other hand, can change over time based on market conditions. This means your monthly payments may increase or decrease.

Fixed-rate mortgages have a fixed interest rate over the entire mortgage term, meaning your total payment and the interest and principal components remain the same throughout your term.

A fixed-rate mortgage is determined by comparable bond yields, so a 5-year fixed-rate mortgage will follow the trend of 5-year bond yields. This is why you can expect a 5-year fixed mortgage rate to be in the 5% to 6% range if the current 5-year bond yield is 4%.

Variable-rate mortgages, on the other hand, have an interest rate that can fluctuate over the mortgage term. This means that depending on the type of variable mortgage you have, your interest portion will adjust according to changes in interest rates.

Variable-rate mortgages are determined by the BoC policy rate, meaning that prime rates will follow when the policy rate changes.

Variable-rate mortgages are determined by the Bank of Canada's policy rate, which influences prime rates. This means that when the policy rate changes, prime rates will change accordingly.

The policy rate is a key factor in determining variable mortgage rates, and it's used by lenders to set their posted rates. Most lenders determine the prime rate based on the policy rate + 2.2%.

The prime rate is the rate lenders use to set their posted rates, which are the rates they advertise. This means that the prime rate is a benchmark for variable mortgage rates.

The posted rate is a combination of the prime rate plus or minus additional percentage points, which can vary depending on the lender. For example, you might see a variable interest rate advertised as prime + 0.5%, or prime—0.5%.

Interest rates impact home affordability inversely, though other factors can play a mitigating role.

For every $100,000 mortgage balance over a 25-year amortization, an approximate $15 increase to your monthly mortgage payment is realized each time interest rates increase by 25bps (equal to 0.25%).

If interest rates increase, this decreases affordability for homebuyers who require a mortgage to finance their purchase. As interest rates increase, so do borrowing costs, leading to higher mortgage payments.

To illustrate this, let's look at an example: if you have a $500,000 mortgage with a 25-year amortization and a fixed mortgage interest rate of 5.14%, you will pay approximately $2,964 in monthly mortgage payments.

If interest rates increase by 1% to 6.14%, your monthly mortgage payment would increase to approximately $3,266, resulting in an additional $302 per month.

If interest rates decrease, this increases affordability, especially for homebuyers who require mortgages to finance their purchase. As interest rates decrease, so does the cost of borrowing money, leading to lower mortgage payments.

Mortgage rates can change frequently, and it's essential to understand how often they fluctuate. Fixed mortgage rates change daily, correlating with the yields of corresponding bonds.

The frequency of mortgage rate changes varies depending on the type of mortgage. Existing variable-rate mortgages can be impacted up to eight times a year, based on lender's prime rates and Bank of Canada policy rate decisions.

Fixed mortgage rates change daily, correlating with the fluctuations in corresponding bonds' yields. This means that the rate you lock in today might be different from the rate you'd get if you were to lock in tomorrow.

Variable mortgage rates, on the other hand, can change as often as a lender's cost of business and risk change. This can happen frequently, and it's essential to stay informed about any changes that might affect your mortgage.

Existing variable-rate mortgages can be impacted up to eight times yearly, directly correlated to the Bank of Canada's policy rate decisions and lenders' prime rates.

Mortgage rates are influenced by the basic principles of supply and demand.

The Federal Reserve's monetary policy plays a significant role in shaping mortgage rates. According to the Board of Governors of the Federal Reserve System, this policy affects the overall economy and, in turn, mortgage rates.

Factors like inflation and economic growth also impact mortgage rates. A strong economy can lead to higher mortgage rates, while a slow economy may result in lower rates.

Your financial health can also affect the interest rate you receive. Keeping your financial health in good shape can help you qualify for better mortgage rates.

Here are some key factors that influence mortgage rates: