If you’re looking to secure a mortgage, understanding the relationship between bond yields and mortgage rates can help you time your borrowing decisions effectively.
What Are Bond Yields?
Government bond yields represent the return investors earn when they purchase government bonds. The yield fluctuates based on market demand, economic conditions, and interest rate expectations. In Canada, the 5-year and 10-year government bond yields are particularly important because they serve as key benchmarks for setting fixed mortgage rates.
The Connection Between Bond Yields and Mortgage Rates
- Bond Yields as a Benchmark for Fixed Mortgage Rates
- Fixed mortgage rates, especially 5-year fixed rates, closely track the 5-year Government of Canada bond yield. When bond yields rise, lenders typically increase their mortgage rates. When bond yields fall, mortgage rates tend to decrease.
- Why Do Bond Yields Move?
- Inflation Expectations: If inflation is expected to rise, bond yields increase because investors demand higher returns to compensate for the declining purchasing power of money.
- Bank of Canada Interest Rate Policy: If the Bank of Canada raises its overnight rate, bond yields usually rise in response. Conversely, if the central bank lowers rates, bond yields tend to drop.
- Economic Conditions: A strong economy with high employment and growth prospects may push bond yields higher, while economic downturns can cause them to fall as investors seek the safety of bonds.
- Impact on Mortgage Borrowers
- Rising Bond Yields → Higher Mortgage Rates: When bond yields increase, banks and mortgage lenders raise fixed mortgage rates to maintain their profit margins.
- Falling Bond Yields → Lower Mortgage Rates: A decline in bond yields usually leads to lower fixed mortgage rates, making homeownership more affordable.
What About Variable Mortgage Rates?
Unlike fixed rates, variable mortgage rates are directly tied to the Bank of Canada’s overnight lending rate rather than bond yields. However, since bond yields and central bank policies are interrelated, changes in bond yields can signal future moves in variable rates as well.
How Borrowers Can Use This Information
- Monitor Bond Yields: If bond yields are trending downward, it may be a good time to lock in a lower fixed-rate mortgage.
- Consider the Economic Climate: If inflation and interest rates are expected to rise, locking in a fixed rate before bond yields climb could save you money.
- Compare Fixed vs. Variable Rates: If bond yields are rising rapidly, a variable rate mortgage might remain lower in the short term, but long-term fixed rates could provide stability.
Conclusion
Bond yields are a crucial but often underestimated factor in determining Canadian mortgage rates. By keeping an eye on bond market trends and economic indicators, borrowers can make more informed decisions about when to secure a mortgage and what type of mortgage to choose. If you’re considering a mortgage or refinancing, consult with a mortgage professional to discuss how current bond yields may impact your borrowing costs.