With Ontario Mortgage Rates fall since the COVID-19 pandemic hit in March, many people are wondering why. The main reasons for the widespread decline in mortgage rates are as follows:
- The Bank of Canada has cut its overnight interest rate,
- Record bond yields on Canadian government bonds, and
- Increased competition among business mortgage lenders
This downward trend in mortgage rates was not only evident in Ontario, as the rest of Canada also recorded record mortgage rates. This article will explain these three reasons in depth and give you a better understanding of why mortgage rates are so low.
Bank of Canada lowers overnight interest rate
As the COVID-19 pandemic took shape and devastated the Canadian and global economy at a rapid pace, Canada’s central bank, the Bank of Canada, cut its overnight interest rate by 0.5% on three occasions in March 2020. This has led to the overnight interest rate dropping from 1.75% before the pandemic to just 0.25% currently. The overnight interest rate is very important because it is the interest rate that chartered banks in Canada are willing to lend money overnight to. Indeed, any chartered bank could simply get an overnight loan from the Bank of Canada if the interest rate offered between the banks were higher. With the overnight interest rate now much lower than before, this means that the cost of borrowing for banks among themselves is also much lower than before. With the lower rates banks will now get when they lend to each other, Canada’s banks have responded by lowering their prime interest rates. The prime interest rate is very important when it comes to a mortgage because this interest rate is used as a benchmark for how a bank decides its mortgage rates. When a bank decides on the interest rate to charge on a mortgage, it can include a spread on the prime rate. This spread can be positive or negative and can make the mortgage higher or lower than the prime interest rate.
For example: A bank considers that the risk is very low on a mortgage loan and offers mortgage rates with a discount of 0.1% from the prime interest rate. The prime interest rate is 2.45%. This means that the mortgage rate you would get is 2.35%. If the same bank offered the same discount on the prime rate but the prime rate was 3.45% due to a higher overnight interest rate, it 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 signaled to the market and consumers that it was going keep interest rates low until at least 2022, yields on long-term government bonds (the interest rate on treasury bills) have fallen. In addition, the Bank of Canada has started purchasing longer term Canadian government bonds in order to further reduce the interest rate on these bonds. This has led to long term government bond yields also having record interest rates. The reason this affects mortgage rates in Ontario is that government bonds pose no risk to lenders. This means that in order to lend money for a mortgage, banks will have to charge a premium on the interest rate offered on a treasury bond. This is so that they are compensated for the added risk of lending money in the form of mortgages and other credit products.
For example: the yield on 5-year Canadian government bonds is 1%. This means that a bank could buy this bond and get an interest rate of 1% on its money risk-free. If the bank charges an additional 1% premium on top of the 5-year government bond yield to offset the additional risk of lending money in the form of a 5-year term mortgage, the mortgage rate would be by 2%. If the yield on government bonds was previously much higher at 2.5%, that means that with the same 1% risk premium, a mortgage rate would instead be 3.5%.
Competition among mortgage lenders
Finally, competition among mortgage lenders in Ontario has helped lower mortgage rates. As buyers across the province scrambled to take advantage of already low interest rates and with additional pent-up demand to buy a home after the initial lockdowns in Ontario were lifted, this led some mortgage lenders to compete. aggressive for business. This competition has led some lenders to lower their mortgage rates to gain more business. Overall, this has led other lenders to lower their rates to be competitive. This is especially true in today’s era where home buyers can search the Internet for the best rate, making it much more difficult for lenders to keep their mortgage rates much higher than their competitors.
Overall, record-breaking mortgage rates can offer homebuyers the opportunity to save money on their interest payments over the life of their term. However, it remains uncertain in the future whether these record high mortgage rates are here to stay, or whether mortgage rates will only be as low temporarily. Since the three reasons for these low mortgage rates are due to the weak economy due to the pandemic, if we have a strong recovery, it could mean that mortgage rates could rise in the future.
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