Why Did Banks Start to Offer Lower Mortgage Rates Than the Current BoC Rate?

Overview of the Mortgage Rate Landscape in Canada

The landscape of mortgage rates in Canada has changed significantly in the past couple of years, largely due to a shift in the Bank of Canada (BoC) policy rate, also known as the overnight lending rate. Traditionally, Canadian variable mortgage rates are directly correlated to the movements in the Bank of Canada benchmark rates. However, despite the BoC’s announcement this past April that it would be holding the benchmark rate at 4.5%, marking the second hold in a row, Canadian mortgage rates have continued to slowly decrease.

While it can be easy to speculate about the cause of this divergence, there are probably a few factors at play. The first thing to consider is the competitive nature of the Canadian banking industry. With the Big 6 Canadian Banks operating as a sort of oligopoly, it can be difficult to gain new customers at a steady rate—especially within their mortgage lending arms. As such, market pressures push these AAA lenders to provide more attractive interest rates than their competitors, in order to attract business. Over time, this practice can lead to a steady decline in mortgage rates.

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BoC’s Role in Setting Interest Rates

The Bank of Canada sets their overnight lending rate based on the benchmark cost of borrowing from other financial institutions. Then, lenders use this policy rate to set the prime rate, which in turn affects variable mortgage and credit rates. The BoC has eight pre-scheduled rate announcements each year, where they announce if the policy rate will rise, fall, or remain unchanged. Typically, the choice to raise or lower rates is tied to the current levels of inflation. The BoC may raise interest rates in an attempt to cool down inflation, or lower rates to stimulate spending and kickstart the economy.

While the Bank of Canada’s overnight lending rate sets a baseline upon which other interest rates can be derived, it isn’t the only factor influencing mortgage rates in Canada. Other elements, such as the cost of funds for banks, their risk tolerance, and competitive pressures, also play significant roles. Consequently, mortgage rates in Canada can sometimes differ from the BoC rate, particularly when banks are fiercely competing for mortgage business. It is also important to note that the policy rate only directly impacts variable mortgage rates. Fixed mortgage rates are typically derived from Canadian bond yields.

Factors Leading to Divergence in Rates

Several factors contribute to the gap between mortgage rates and the Bank of Canada interest rate. One key factor is competition. As the weather begins to warm up, banks, lenders, and realtors alike have begun competing for the inflow of new real estate clients just entering the market. Since the Canadian housing market is quite seasonal, Spring often comes with a surge in activity — incentivizing banks to offer lower, promotional rates.

Another significant factor is that 5-year bond yields have fallen in the past few months. This means that fixed mortgage rates inevitably followed suit, and perhaps, this may eventually affect variable rates as well. Many Canadians are unaware that only variable rates are actually tied to the BoC policy rate, and may be surprised when fixed rates behave differently. In this case, the bond yields falling may indicate a potentially recessionary environment , or an anticipated BoC rate cut.

For the first time in a long time, some fixed rates are actually lower than variable rates. This may make the current market difficult to navigate or predict, especially if you are a first-time homebuyer. Luckily, Clover Mortgage can help connect you to the best rate possible by leveraging our network of 80+ lenders and over 100+ mortgage products. Contact us to get started with a free consultation today.

FAQ

Why are mortgage rates lower than prime rates?

Mortgage rates may be lower than prime rates due to a number of factors, but most recently, it has come down to the following:

1. 5-Year bond yields are down, which means that fixed rates are down. The prime rate mainly impacts variable mortgage rates, and as a result, a hold of the prime rate does not mean that fixed rates cannot drop.
2. There is increased demand for residential real estate supply in the Spring season. Big banks and lenders may be offering more competitive rates to try to capture as much of this new client market as possible.

Why do banks offer lower interest rates?

The major reasons banks provide lower interest rates are to remain competitive and draw in additional business. Banks must provide competitive rates to differentiate themselves in a market where consumers may readily compare rates using online mortgage calculators. Lower interest rates also have the effect of encouraging borrowing, which aids banks in expanding their mortgage portfolios.

Building enduring ties with their customers is another reason why banks could provide lower interest rates. Banks hope to cultivate client loyalty and stimulate usage of other banking goods and services by offering competitive mortgage rates. Even if the initial mortgage rates are lower, this cross-selling tactic can eventually lead to more profitability.

Are mortgages tied to their prime rates?

Variable rate mortgage (and lines of credit such as HELOCs) are directly correlated to the prime rate. When the prime rate goes up, variable rates go up. Fixed rate mortgages are mainly tied to Canadian bond yields (especially the 5-year bond yield). However, changes to the prime rate can still indirectly influence fixed rate mortgages by changing overall market sentiment and dynamics.

For those navigating this landscape, tools like a mortgage calculator can be invaluable for comparing options and making informed decisions.