What affects variable and fixed Canadian mortgage rates?

Over the past three years, Canadian mortgage rates have increased due to major economic shifts.

Initially, the government reduced rates to stimulate the economy during the COVID-19 pandemic, which led to high inflation.

In response, the Bank of Canada gradually raised rates through a series of hikes, eventually reaching an overnight rate of 5%. This rate has remained unchanged since July 2023. As a result, both fixed and variable mortgage rates have increased, impacting homeowners’ borrowing costs.

There are so many factors that influence the economy and ultimately lenders and the amount they charge on home loans, including unemployment, inflation, consumer confidence and the oil price to name a few that it can be extremely difficult to keep all these metrics straight in your head.

Many people believe that the Bank of Canada’s monthly interest rate decisions directly affects all mortgage rates, but that’s not the case. Variable (ARM or adjustable mortgage rates) and fixed mortgage rates in Canada are influenced by different factors.

Read more: What type of mortgage and term should you get?

Variable mortgage rates

The Bank of Canada plays a significant role in determining variable mortgage rates by setting the overnight rate, also known as the policy interest rate.

The overnight rate is the interest rate at which major financial institutions borrow and lend money one-day (or "overnight") among themselves. The bank uses this rate to influence monetary policy and control inflation.

Financial institutions use the overnight rate as a benchmark to set their prime rates, which is the interest rate that banks offer to their most creditworthy customers, including variable-rate mortgage holders.

Related: How interest rate changes affect your variable rate mortgage

Variable mortgage rates are the result of the prime rate plus or minus a certain percentage (for example, prime - 0.60%). Whenever the prime rate changes, the interest rate on a variable mortgage will also change.

So, if the overnight rate goes up, the prime rate goes up too, making your mortgage payments higher. However, if the overnight rate goes down, the prime rate drops, and your mortgage payments will decrease. Obviously, this type of mortgage is a great option if interest rates are falling.

The problem is that during periods of financial instability, such as a credit crunch or a recession, banks will become more cautious in lending funds to each other out of fear of not getting their money back. This leads to increased interbank lending rates, which banks then pass on to customers as higher interest rates.

Fixed mortgage rates

The Canadian government plays another central role in the fixed mortgage rate market, specifically the price of government bonds, and these interest rates are influenced by the bond yield.

Bonds are typically considered safer investments than stocks, especially government bonds, and when the stock market is booming, investors most likely would make a higher return on investment in equities, which means there is a lower demand for bonds, so they decline in value and increase their yield.

Learn more: How bond yields affect fixed mortgage rates

On the other hand, when the Canadian economy becomes less stable and stocks do not look as enticing, the demand for bonds increases and their yields decrease. As a result, when the government of Canada’s longer term bond prices, such as the five-year increase, this decreases the yield, typically reducing the five-year borrowing costs for mortgage lenders who can then pass these savings onto customers in the form of lower five-year fixed mortgage rates.

However, during this unprecedented economic time, due to the lack of liquidity in the markets, where banks around the world are hesitant to lend to each other and are holding onto their own cash, banks have had to pass these higher costs to customers in the form of higher fixed mortgage rates.

Lock in your mortgage rate

If you are looking to buy a house in the next few months or need to refinance soon, you may be interested in additional security offered by locking in your mortgage rate. You can do this by going to a lender or broker and get ‘pre-approved’ which means that you have access to that rate, regardless of any other factors, for a specified period of time. Speak to your lender or mortgage broker as many offer rate guarantees of up to 120 days.

What will save me more money – fixed or variable rates?

There have been many studies and debates on which is better for borrowers — variable mortgage rates or fixed mortgage rates.

While variable rates start lower, they can rise quickly with economic changes, leading to higher costs. So, ultimately choosing between the two mortgage rates depends entirely on your financial situation and personal risk tolerance.

A report by RATESDOTCA found that over the course of the ten rate hikes between July 2021 and September 2023, variable-rate mortgage holders paid 63% more in total interest compared to fixed-rate holders. That translates this into  $23,579 more in cumulative interest than someone with a fixed-rate mortgage over the same period.

During this time, Canadians who had opted for fixed-rate mortgages during the low-interest days of the mid-pandemic enjoyed stable monthly payments at a much lower rate, providing them with financial stability and protection against those ensuing interest rate hikes.

Variable-rate mortgage-holders carry the risk of higher costs over time if interest rates rise – though they benefit if rates decrease...

Since July 2023, the BoC overnight rate has remained at 5%, with many economists predicting rate cuts in the latter half of 2024. And between then, anyone renewing from a fixed rate will have seen their interest rates jump by several percentage points. As the overnight rate incrementally eases, so will variable mortgage rates. Meanwhile, anyone who opts for a fixed mortgage rate will miss out on any payment reductions from the rate cuts.

If you're still unsure about what type of mortgage you want to go for, seeking expert advice and comparing rates across various mortgage lenders can help you make the right decision.