For many families, the most important aspect of their finances is their mortgage. An important question in this regard is: how are mortgage rates determined? If you know how rates are determined, then you might have a better idea of where they are going. Here is what mortgage expert Lior Hershkovitztold me in an interview:
LM: How are fixed and variable mortgage rates determined?
LH: Fixed mortgage rates move in tandem with the bond market while variable rates move with the lender’s Prime rate, which is based on the Bank of Canada’s overnight rate. In a way, they both move with the economy as a whole. When investors are nervous about the financial markets, they shift more of their money into the security of government bonds, resulting in a reduction of the yield that these bonds pay. When bond yields are lower, fixed mortgage rates would head down. It’s important to note, however, that any change in the yield of the benchmark bond is not passed immediately to the consumer. Naturally, lenders react quicker when yields increase. However, they take their time to pass the savings when yields decrease. Conversely, when investors are bullish about the markets, government bond yields would increase to make them more attractive. Under this scenario, fixed mortgage rates would increase.
Variable rates change whenever the lender reset its Prime rate. Most lenders reset their Prime rate almost immediately after the Bank of Canada changes its benchmark rate. However, as we have seen during the financial meltdown of 2008, even though the Bank of Canada reduced its overnight rate to nearly zero, the banks were reluctant to pass the full reduction to its customers by claiming that their own borrowing costs remain elevated. Moreover, lenders can control their variable rates by manipulating the increment/decrement to Prime. Recalling once again the financial crisis of 2008, lenders increased their increment to prime from Prime – 1% to Prime + 1%. While we are now almost down to Prime – 1% again, the reduction period has been agonizingly slow.
To be continued.