Mortgage rates and how they are defined

Variable rate mortgages usually work better than to fix your mortgage in a declining interest rate market.

As we have seen benchmark interest rates increased in 2 out of 2 of the last Bank of Canada's meetings, the tide has now turned and it may be advantageous to now lock in your mortgage.

A 5 year fixed rate mortgage can be had at a shade or two under 4 points. Interestingly enough, fixed rate packages have been recently on the decline as variable rate mortgages have been on the incline this year.

The variable rate is set and calculated against the banks prime lending rate. Bank prime lending rates are directly affected by the Bank of Canada's overnight lending rate. It is this "overnight" rate that is used as the interest rate that banks charge eachother to cover their short term daily transactions. As the Bank of Canada raises its key interest rate, this in effect increases the banks cost of borrowing through short term daily transactions which in turn increases their prime lending rate (as it is these "short term daily transactions" that the banks borrow money for variable rate product). Then of course the cost of borrowing rises for consumers who take on variable rate products.

Essentially fixed rate mortgages are affected by the yielding rate on bonds. The banks rely on the bond market to raise money for these kinds of mortgage applications. So essentially because bond yields are at lower lows, the base rate for fixed rate mortgages are currently sitting at near all time lows.

Banks are in business to make profit. Their commodity is money. They purchase money at rates that are cheaper than they can loan the money out at. Essentially, they pay their depositors low rates of interest on their bank accounts, term deposits, and GIC's and lend out at higher interest rates through mortgages.

A government of Canada bond represents a risk free investment to the banks. When the banks decide to load money for a mortgage, they are taking on risk with their capital (our deposits) and covering expenses to set up and service the loan. As prudent business practice, they will set their mortgage rates high enough above the equivalent bond yield to supplement their business practices for their costs and provide them with a profit margin for the added risk they take on or services that they provide.