With Ontario mortgage rates falling ever since the COVID-19 pandemic hit in March, many people are wondering why. The main reasons for mortgage rates falling across the board are:
- The Bank of Canada cutting its overnight interest rate,
- Record low bond yields on Canadian Government bonds, and
- Added competition among mortgage lenders for business
This trend of low mortgage rates has not only played out in Ontario, with the rest of Canada also seeing record low mortgage rates. This article will explain all three of these reasons in depth, and will give you a better understanding of why mortgage rates are so low.
The Bank of Canada Cut its Overnight Interest Rate
As the COVID-19 pandemic took shape and devastated the Canadian and world economy at a rapid pace, Canada’s central bank which is The Bank of Canada, cut its overnight interest rate by 0.5% 3 times in March 2020. This led to the overnight interest rate falling from 1.75% before the pandemic, now to just 0.25% currently. The overnight interest rate is very important, as it is the interest rate that chartered banks in Canada are willing to lend money overnight to each other at. This is because any chartered bank could just get an overnight loan from the Bank of Canada if the interest rate offered between banks was higher. With the overnight interest rate now being much lower than before, it means that the cost of borrowing for banks between each other is also much lower than before. Because of the lower rates banks will now get when lending to each other, banks across Canada responded by cutting their prime interest rates. The prime interest rate is very important when it comes to a mortgage loan, as this interest rate is used as a benchmark for how a bank decides on their mortgage rates. When a bank is deciding on what interest rate to charge on a mortgage, they can include a spread on the prime rate. This spread can be positive or negative, and can make the mortgage loan either higher or lower than the prime interest rate.
For example: A bank feels like the risk is very low on a mortgage loan, and offers mortgage rates at a 0.1% discount to the prime interest rate. The prime interest rate is at 2.45%. This means the mortgage rate you would get is 2.35%. If the same bank offered the same discount to the prime rate but the prime rate was 3.45% because of a higher overnight interest rate, this would make the mortgage rate much higher, at 3.35%.
Record Low Bond Yields
As the Bank of Canada cut its overnight interest rate in March 2020 and signalled to the market and consumers that they were going to keep interest rates low till at least 2022, long-term government bond yields (the interest rate on government treasury bonds) fell. As well, the Bank of Canada started purchasing longer-term Canadian government bonds as a way to bring down the interest rate on these bonds even more. This has led to long-term government bond yields also having record low interest rates. The reason this impacts mortgage rates in Ontario is because government bonds have no risk to lenders. This means that to lend out money for a mortgage, banks will need to charge a premium to the interest rate offered on a government treasury bond. This is so that they are compensated for the additional risk of lending money in the form of mortgages and other credit products.
For example: a Canadian 5-year government bond yield is 1%. This means that a bank could purchase this bond and get an interest rate of 1% on their money risk-free. If the bank charges an additional 1% premium on top of the 5-year government bond yield to compensate for the added risk in lending money out in the form of a 5 year term mortgage, the mortgage rate would be 2%. If the government bond yield was much higher before at 2.5%, this means that with the same 1% risk premium, a mortgage rate would be 3.5% instead.
Competition across Mortgage Lenders
Finally, competition amongst mortgage lenders in Ontario has helped lead to lower mortgage rates. With buyers across the province rushing to take advantage of already low interest rates and with the added pent-up demand to buy a home after initial lock downs were lifted in Ontario, this led to some mortgage lenders competing aggressively for business. This competition has led to some lenders lowering their mortgage rates to win more business. Overall, this has led to other lenders needing to lower their rates in order to compete. This is especially true in today’s age where homebuyers are able to shop around for the best rate over the internet, which makes it much harder for lenders to keep their mortgage rates much higher than competitors.
Overall, record low mortgage rates can present homebuyers with the opportunity to save some money on their interest payments over the life of their term. It remains uncertain however going into the future if these record low mortgage rates are here to stay, or if mortgage rates will only be this low temporarily. Considering all three reasons for such low mortgage rates are because of a weak economy from the pandemic, if we do have a strong recovery it may mean mortgage rates could rise in the future.
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