Unless you plan to pay for your entire property upfront, you will likely have a mortgage when you buy real estate. Mortgage interest rates are a huge factor in a real estate investment and can take some work (and some luck) to ensure you get the best interest rate available to you.
Though mortgage interest rates are usually only a few percentage points, the total value of your home means these seemingly small numbers can add up. The difference between 3% and 4% in mortgage rates will make a difference on your monthly mortgage payment and could mean thousands of extra dollars in interest over the course of your mortgage.
The thing about interest rates is that there is no single rate offered at any time. Mortgage lenders offer various mortgage products, each with its own terms, additional premiums, and interest rates. The interest rates you receive from one bank are based on their own evaluation of investment risk and future market forecasts and may vary to the rates offered by another bank.
Borrowing money is risky and banks are businesses that also want profit, so they have to set their lending rates above their own borrowing rate, sheltering them from risk. This is why the better the rate for the borrower, the higher the risk and vice versa for the lender.
If you want to get the best rate available, it’s good to know about the condition of the market and where things are set to go in the future. For example, should you lock in a mortgage rate now, or stick with a variable rate?
This decision will depend on how you think rates are likely to move in the coming months and years.
In this article, we will cover the current situation with mortgage rates in Canada, some information about how rates are determined, and where they might go in the near future.
The current situation
Rates are changing all the time so you should always check with banks for their most recent mortgage rate and any special rates they can provide you. However, what follows are some of the rates of Canada’s top five big banks as of currently*:
*rates subject to change
Note that these are only the base rates and banks may offer special discounts. The discounted mortgage rate available to each customer will vary. The discounts you are offered rely on your personal finances and income, your credit score and past credit history, and the value of the property being purchased among other factors.
Currently, mortgage rates are considered low and are gradually increasing as the economy recovers from the effects of the COVID-19 pandemic.
Low mortgage rates along with unusually high demand for homes have caused an increase in home prices. This is because as interest rates drop, the budgets of Canadians looking to buy can handle larger mortgages. In a housing market with such high demand, this pushes home values up.
How mortgage rates moved in the past
Understanding how mortgage rates moved in the past is useful to help you see trends in the current market and to help in understanding what factors play a role in influencing rates.
Generally, mortgage rates rise in reaction to the state of the economy. In a healthy economy, many people are looking to borrow, so the cost of lending and borrowing goes up, leading to an increased mortgage rate. In weaker economic times, rates tend to decrease to make borrowing more appealing for the smaller number of investors.
This relationship is on clear display in the mortgage rate trends of the past 20 years. In the early 2000s, mortgage rates gradually climbed. Following the 2008 financial crisis, rates lowered once again. The same rising process was seen in the 2010s, culminating in the 2020 pandemic which again weakened the economy and saw rates hit record lows in accordance.
How mortgage rates are determined
There are various things that play a part in determining mortgage rates that you can receive from your lender. These various factors include:
Bank of Canada overnight rate
The Bank of Canada maintains a benchmark interest rate known as the overnight rate or the policy interest rate. This rate serves as one of the main drivers of rising rates in the Canadian economy and is one of the primary tools of the Bank of Canada’s monetary policy.
The Bank of Canada adjusts the overnight rate in order to influence the economy, most importantly the rate of inflation. The Bank of Canada generally sets the overnight rate to target an inflation rate of 2%.
In short, the overnight rate is a target interest rate at which financial institutions and the Bank of Canada charge loans between each other. Essentially, banks are always moving money back and forth and lending each other money when they are in need of funds.
Of course, no one lends for free.
The Bank of Canada influences the rate banks to charge each other by setting their own lending and borrowing rates on either side of the target rate. If one bank can not lend from any others, they can pay higher interest to the Bank of Canada as a last resort.
Conversely, a bank with excess funds can get a lower than average interest rate from the Bank of Canada if no other option is available. Since the banks want to avoid borrowing or lending to the Bank of Canada, there is simultaneous upward pressure and downward pressure that keep the target rate in place.
The banks, therefore, incur a cost in the transaction of money at the rate of the overnight target. This rate then gets passed on to anyone who wants to borrow money from the bank. So for any mortgage, you must first begin with the overnight rate as set by the Bank of Canada.
Any lower rate would mean the bank is losing money by lending to you.
The overnight rate has the strongest effect on variable mortgages, while fixed-rate mortgages are more influenced by government bond yields.
The Bank of Canada has committed to holding the current low overnight rate of 0.25% until at least 2022. The Bank of Canada has justified their choice by stating that “recovery continues to require extraordinary monetary policy support”.
Government of Canada bonds
The Government of Canada offers bonds to investors in terms of one to 30 years. Bonds are attractive to investors because they offer what is essentially the lowest risk for investment. A Government of Canada bond is fully guaranteed to be repaid by the government upon completion of the term, as well as paying out interest until then.
What makes bonds less appealing to most investors is that they take a long time to reach maturity and generally have lower growth potential than say stocks or real estate.
Essentially, a bond is money you lend to the government who pays you interest and, upon reaching maturity, the full principal cost of the bond is repaid. The interest rates that a bond returns are its yield and when this number goes up, interest rates tend to increase as well.
Generally, banks look to the five-year fixed bond yield as the rate that drives mortgage rates.
Bond yields fell a lot in the last year, allowing banks to offer the lower rates they were. In the past couple of months, yields are on the rise again and the banks are raising their fixed mortgage rates in reaction.
Advice for choosing a mortgage
Fixed mortgage rates mean increased fees
You may be attracted to the idea of a fixed rate for your mortgage, especially as fixed rates are looking to increase in the near future. However, offering a fixed-rate mortgage poses a significant increase in risk for the lender, meaning you will end up paying premiums for fixed rates.
Compare the rates above between an RBC variable mortgage and a five-year fixed mortgage. The five-year fixed rate is almost double the variable rate. This difference between variable and fixed rates is seen across essentially all lenders.
The major benefit of fixed rates is the peace of mind that you are sheltered from any major unexpected rate increases. However, you pay for that privilege. For example, fixed mortgages often have very high cancellation rates or an increase in closing costs.
On the other hand, with the Bank of Canada committed to keeping a low overnight rate for the foreseeable future, a variable mortgage may be a better value for you right now. Many variable mortgages offer you the ability to lock into a rate later on if you want the security of a fixed mortgage.
Variable mortgage rates mean increased risk
While variable mortgage rates are much cheaper than fixed rates, you exchange those savings for increased risk on your loan. The risk is that rates could increase and you will have to pay more.
In fact, there is a very good chance that over the full course of your mortgage, prices will change, whether that is an increase or decrease is not clear.
The first piece of good news is that mortgage rates tend not to move so fast that you will be blindsided by a major increase. Furthermore, mortgage rates increase based on external factors that can be monitored, so rate increases will not be too surprising for those paying attention.
Based on current indicators, variable rates are likely to remain low for the near future, while fixed mortgage rates are already increasing.
Forecast for future mortgage interest rates
As mentioned earlier, there are many factors that all play a part in setting mortgage rates. Let’s look at some of those factors and use them to get an idea of how high mortgage rates could increase by the end of next year.
Economic recovery beginning
Firstly, the economy, in general, is recovering nicely from a troubling two years. Most analysts agree currently that following a smaller third wave and fourth wave of cases, the worst of the pandemic and its resulting economic recession is behind us and we are entering a period of economic recovery. While the path back to pre-pandemic levels of economic performance will take years, we are now on the way. This will likely lead to an increase in both fixed and variable rates over the next few years.
Housing levelling out
In the real estate market specifically, prices and sales seem to be levelling out. Real estate boards across the country are reporting that after meteoric increases since the second half of 2020, the rate of increases is slowing and the market is reaching a balance point. Some are even calling for a correction to housing prices in the next year or so.
Bond yields up
Bond yields are continuing their upwards trend and big banks, as well as smaller lenders, are already increasing their fixed mortgage rates. Already the five-year bond yield has surged to 1.4%, half of its peak of about 2.4% in 2018, after hitting a low of 0.3% earlier this year.
The Bank of Canada overnight rate is also set to increase in 2022, though they should remain relatively low for a little while. The Bank of Canada meets on eight dates a year to set the rate, so it could change up to eight times in a year. It’s believed they will keep the rate at its current level through the second half of 2021 and until around the second quarter of 2022, even despite inflation soaring above their 2% target. The rate is forecasted to raise up to 0.5% in 2022.
The outlook for 2023 and beyond is much harder to predict. Just as the Canadian economy is now recovering from the recession, so are many other economies globally. However, not every country is recovering so soon or at the same rate. Unfortunately, economic systems are not always predictable, and the farther we forecast, the more uncertainty we have to deal with.
What investors need to know
If you are looking to buy or sell in real estate, the trends in mortgage rates are very important for you to understand. Even if you plan on holding your property, you should be aware of how rates can change and affect your investment. Ultimately, no model can predict the future and you should always discuss your portfolio with a knowledgeable mortgage broker who can provide you with the best advice. Nonetheless, here are some basic tips.
For buyers, expect fixed rates to continue increasing and variable rates gradually rise in the next year. Though the stability of variable rates for the near future is a good sign to consider variable rates for any new mortgages. If you do choose to go for a fixed mortgage, consider locking in a rate with a mortgage broker sooner rather than later to ensure you don’t go over budget.>
However, with many predicting a correction or downturn in house prices, buying today may actually lose you money in the next few years. This doesn’t mean that your property won’t accumulate value again further down the line but be prepared for some uncertainty. If you don’t think you will be able to sleep at night knowing your investment could drop, consider waiting a few years for things to stabilize more.
For those looking to sell, consider the current state of housing prices. If you choose to sell now, you can lock in those high prices while they are still high. With the uncertainty of prices now, holding out may mean losing out. Much of our current trends are tied to the COVID pandemic, and as that begins to clear, it is not certain how prices will go.