Canadian lenders are cutting fixed mortgage rates following a drop in bond yields. But what’s behind these latest moves?
Canadian lenders are once again trimming their fixed mortgage rates, offering additional relief to today’s mortgage shoppers.
The latest rate cuts follow a sharp drop in the Government of Canada bond yields, which typically influence fixed mortgage rate pricing. After hitting a six-month high in late April, bond yields—which move inversely to bond prices—have been trending downward.
The steepest drop has taken place over the past week, with yields down roughly 30 basis points, or 0.30%.
As a result, many lenders have reduced their rates, with some making substantial cuts.
“Five-year fixed rates are way down and we may see two-years at 4.99% soon,” rate expert Ron Butler of Butler Mortgage told CMT. “The downward path for both fixed and variable rates is now certain.”
The lowest nationally available deep-discount uninsured 5-year fixed rate was down roughly 25 basis points (0.25%), according to data from MortgageLogic.news. Other terms have seen reductions ranging anywhere from 5-20 bps.
Among the Big 5 banks, CIBC this week trimmed nearly all of its special-offer rates an average of 20 bps.
What’s driving bond yields lower?
As we’ve reported previously, Canadian bond yields, and in turn mortgage rates, take much of their lead from what happens south of the border. And this latest move is no different.
“You can see we’re being pulled along as usual by news south of the border,” Bruno Valko, VP of National Sales for RMG, told CMT, pointing to a chart comparing Canada’s 5-year bond yield and the U.S. 10-year Treasury, which has fallen below 4.00% for the first time since the start of the year.
Of course the big news out of the U.S. this week was the Federal Reserve rate hold on Wednesday, where comments by chair Jerome Powell boosted market confidence of two quarter-point rate cuts to come before the end of the year.
“Bond traders south of the border are 90% sure of two rate cuts in the U.S. by the end of 2024 and there is even talk of three cuts, therefore U.S. Treasury yields fell and Canadian yields followed suit,” explained Butler.
That news carried more sway than this weeks’ latest Canadian GDP figures, which showed better-than-expected albeit slowing growth in May.
But still, signs are growing that both the U.S. and Canadian economies are slowing, struggling under their weight of high interest rates.
And as Valko reminds us, bad news can be good news for borrowers.
Implications for mortgage selection
The steady easing of fixed mortgage rates is a welcome relief for the countless Canadian borrowers—some 2.2 million, representing nearly half of all Canadian mortgages—who will see their mortgages come up for renewal over the next two years.
At the same time, existing variable-rate mortgage holders and those considering a variable rate are also seeing relief.
Variable mortgage rates have fallen by 50 basis points (0.50%) since June thanks to the Bank of Canada‘s two consecutive quarter-point rate reductions. Rates are expected to fall further by year-end and beyond. (In case you missed our previous piece: Will the Bank of Canada deliver another 175 bps in rate cuts? TD and CIBC say yes)
Don’t forget the prepayment penalties
One important consideration for those mulling their mortgage options is the cost of getting out of a high-rate product if rates fall significantly in the years ahead.
An Interest Rate Differential (IRD) penalty, often substantial, can significantly impact the cost of breaking a mortgage early. These penalties can pose a considerable financial burden for certain borrowers looking to switch mortgages before the term ends.
“It’s important for brokers and their clients to understand that if they believe rates are going to drop in the next 12 months, the more flexible the mortgage the better,” Valko tells us. “Regardless of term, if a fixed rate is taken, the IRD penalty and the transparency of its calculation is important.”
Valko adds that this is especially true for anyone who may end up switching or refinancing a mortgage in a year or two, as IRD penalties would generally apply for any term beyond that timeframe, including 3-, 4- and 5-year fixed mortgages.
Valko notes that RMG’s special-offer 5-year fixed product is currently popular among borrowers, while Butler says he’s seeing increased interest in 3-year fixed terms.
Recent Bank of Canada data confirms the trend towards shorter-term fixed mortgages, with over 50% of new mortgage borrowers opting for 3- or 4-year fixed terms in April.
While shorter-term fixed mortgages may have a near-term advantage over variable rates, Butler suggests that those willing to “gamble” should consider a variable rate, but only if they can handle the added rate and payment uncertainty.
Another benefit of a variable rate is that the penalty to switch to a fixed-rate mortgage in the future is limited to three months’ interest.
“The client has to determine which term/rate is best for them,” says Valko. “However, as indicated, even if/when taking a fixed mortgage term, the potential IRD calculations of the lender and flexibility of the mortgage in the future should be considered.”
