When the Bank of Canada (BoC) makes interest rate cuts, variable rate mortgage pricing typically moves, too.
That’s because the central bank’s benchmark rate influences the interest rates that banks charge on variable rate mortgages, such as the TD Prime Rate, which impacts the interest rates on loans such as variable rate mortgages and home equity lines of credit (HELOCs).
So, if the BoC cuts its interest rate, banks typically follow, and lower their interest rate on variable rate products, too.
If the BoC hikes its interest rate, customers typically see higher interest rates on variable rate mortgages.
So why aren’t BoC rate moves reflected in the same way when it comes to fixed rate mortgage pricing?
Well, the BoC’s interest rate does influence fixed rate mortgages, but less directly.
Let us explain.
How fixed rate mortgages are priced
Fixed rate mortgages are products that have pricing locked in for a specific period of time. If you have a five-year fixed rate mortgage term, your interest rate and payments are set for the entire term. That means you won’t see any fluctuations in your interest costs, as long as you make all of your regular payments.
Rates for these mortgages are based on the bond market, not directly on the BoC’s interest rate. Banks typically use the Government of Canada bond yield as a benchmark for fixed rate mortgage pricing.
A bond is simply a loan from investors to a government or company that pays a fixed interest (or a "coupon"). It’s essentially a way for government or companies to borrow money directly from investors.
“So, when you buy a $1,000 bond, and it pays a coupon of 5%, you’re going to earn $50 in interest on an annual basis,” said TD Economist Maria Solovieva. “And importantly, when your bond expires, you also receive your $1,000 back.”
At the time of issuance, the coupon rate equals the bond's yield. As market conditions change, the bond yield will also change.
That’s because bond yields reflect where the market is likely headed, based on economic factors such as inflation and expectations for the BoC’s interest rate. In other words, bond yields offer financial institutions a decent snapshot of where fixed rate mortgage rates should be priced in keeping with the future state of the economy.
So, while the BoC's interest rate still matters, it affects fixed mortgage rates indirectly by shaping market expectations.
Deciding between a fixed rate mortgage and variable rate mortgage
It can be tough choosing between a fixed rate or variable rate, especially if you’re new to homeownership. There are factors to consider when determining which type of interest rate is right for you.
“If you sign up for a fixed rate term, your payment will be fixed for the next three or five years – however long the term of you mortgage is,” said Abbie Wang, a Senior Manager with the Real Estate Secured Lending team at TD.
“There is payment stability. There's not going to be any volatility, regardless of how the market is moving.”
With a variable rate, on the other hand, your interest rate can fluctuate based on changes to your bank's prime lending rate, which is influenced by the BoC’s lending rate.
For Canadians with variable rate mortgages, BoC rate cuts can mean more of their mortgage payment goes towards the principal of the mortgage, and less towards interest. Homeowners who have a variable rate mortgage with variable payments could see their total payment shrink.
“For first time homebuyers, I highly suggest looking at payment affordability instead of looking purely at interest rates,” Wang said. “It’s important people evaluate what will be the most comfortable situation in their budget to manage.”