19 Jul

Why you should care about the banks’ posted rates on mortgages

Mortgage Facts & Stats

Posted by: Garth Chapman

There are not very many Canadians these days who would accept the posted rate for a mortgage, but that doesn’t mean no one should care when the banks drop their posted rates.

What’s key about the posted rate is that it is used by the Bank of Canada to create what is called the ‘qualifying rate’. The prime rate is 2.45% as of the last change on March 30, 2020 and you can obtain a Variable Rate mortgage at rates that are below the Prime Rate, although the discounts to Prime have gone from nearly 1.0% to about 0.25% with the advent of COVID-19.  And remember, you will qualify based on the ‘Stress Test rate’ — meaning you must borrow based on a higher monthly payment which ultimately means you will be restricted to taking on a smaller mortgage than in the good old days when you qualified on the actual rate of your new mortgage.

If you took a fixed rate mortgage, as 75% of Canadians have been doing for at least 5+ years, and you want to pay off the mortgage now, you would be subject to a mortgage penalty based on a very complex calculation call IRD (Interest Rate Differential).  Ostensibly this is to make the bank whole for you breaking your contract early as the bank would have contracted to pay a given interest rate to the entity that provided the funds for your mortgage for the entire term. When you break the term the bank is still obligated to the payments they committed to. And that’s fair enough, but many would argue that the IRD calculations are not in keeping with the above concept. And that’s because they use the Posted Rate in calculating the penalty.  In fact there is a class-action lawsuit winding its way through B.C. courts now on this very issue Class-action lawsuit against CIBC for mortgage penalties

Read on here for the skinny on this subject in this Financial Post article Why you should care about the banks’ posted rates on mortgages

 

19 Jul

Understanding what drives Variable rates and Fixed rates

Financial

Posted by: Garth Chapman

Your Variable Mortgage Rates are driven by your bank’s Prime Rate which is set individually by each Bank. They normally (but not always) move in sync with changes in the Overnight Rate, which is set by the Bank of Canada (BoC) and is used as a basis for one-day (or “overnight”) borrowing between the major lenders and financial institutions.

The BoC is responsible for monetary policy, the goal of which is to keep inflation near the mid-point of a 1 to 3 per cent target range, ideally 2%. The BoC is equally concerned with significant movements in the inflation rate, both above the 2% mid-point and below it. When demand is strong, it can push the economy against the limits of its capacity to produce. This tends to raise inflation above the midpoint, so the BoC will raise interest rates to cool off the economy. When demand is weak, inflationary pressures are likely to ease. The BoC will then lower interest rates to stimulate the economy and absorb economic slack.

So when the economy heats up and there is a threat that inflation could get beyond the 1 to 3 per cent target the BoC may increase the overnight rate, which drives the Prime Rate. The schedule of dates when the BoC reviews and sets the Overnight Rate is found here http://www.bankofcanada.ca/core-functions/monetary-policy/key-interest-rate/

Fixed Mortgage Rates are driven by the Bond markets. Typically, when bond rates (also known as the bond yield) go up, interest rates go up as well. And vice versa. Don’t confuse this with bond prices, which have an inverse relationship with interest rates.

Investors turn to bonds as a safe investment when the economic outlook is poor. When purchases of bonds increase, the associated yield falls, and so do mortgage rates. But when the economy is expected to do well, investors jump into stocks, forcing bond prices lower and pushing the yield (and mortgage rates) higher.

The spread between 5-year Government of Canada Bonds and 5-year mortgage rates varies within a range that has fluctuated in recent years. You can follow the 5-year Bond Yield in Canada on the BoC website here and you will notice that a period of Bond yield increases or drops will almost always be followed by a corresponding change in fixed rates for mortgages.