Understanding How Government of Canada Bond Yields Influence Mortgage Rates

Mortgage rates in Canada are influenced by many factors, but one of the most significant is the yield on Government of Canada bonds. Here, we’ll break down what bond yields are and explain their impact on fixed-rate mortgages in particular.

But before we go there, let's clarify something:

Fixed-rate mortgage rates in Canada are priced off of Government of Canada 5-year bond yields that are, in turn, influenced by the U.S. Treasuries.
Variable-rate mortgages are affected by the Bank of Canada's monetary policy, namely interest rate hikes and cuts that, in turn, impacts commercial banks' Prime lending rate.

What Are Bond Yields?

Bond yields can be thought of as interest rates on loans from the government. When the Government of Canada needs to raise money, it sells bonds to investors, offering them a return on their investment. Bond yields indicate the amount of interest investors earn from these bonds, and they fluctuate according to market conditions. This fluctuation influences other types of interest rates in Canada, including mortgage rates.

How Bond Yields Affect Fixed-Rate Mortgages

Fixed-rate mortgages offer homeowners a stable interest rate throughout their term, giving budget certainty. When you lock in a fixed-rate mortgage, your rate is directly influenced by current bond yields. As bond yields rise or fall, fixed-rate mortgage rates adjust accordingly. However, once your fixed rate is set, it remains consistent for the term of the mortgage, so fluctuations in bond yields only affect your mortgage rate when you initially lock it in.

Why Do Bond Yields—and Mortgage Rates—Fluctuate?

Bond yields fluctuate based on the financial market’s risk-reward balance. When market conditions become riskier, bond yields rise to attract investors. Higher bond yields, in turn, lead to higher borrowing costs for the government, which can drive up fixed mortgage rates. 

Government bonds have a near-zero risk of default since they are guaranteed to be repaid. Mortgages, on the other hand, carry more risk due to the possibility of default or early repayment, which may disrupt the investment’s return. This additional risk results in mortgage rates being set at a premium over bond yields.

How Much Higher Are Mortgage Rates Priced?

In normal market conditions, Canadian mortgage rates are typically priced about 120 basis points (or 1.2%) above the rate for government bonds. This difference, known as the "spread," fluctuates based on market conditions, investor interest, and the availability of other investment options.

Factors like corporate bonds and stock markets—both domestic and international—also compete for investor attention, affecting this spread.

Understanding the Bond Price-Yield Relationship and Mortgage Rates

The relationship between bond prices and bond yields is inverse: when bond prices go up, yields go down, and vice versa. Fixed mortgage rates tend to move in tandem with bond yields. So, when bond yields increase, fixed mortgage rates rise; when yields decrease, fixed rates generally drop as well. This close link between bond yields and fixed mortgage rates is a key reason why it’s valuable to track bond market trends when considering a mortgage.

By understanding the influence of bond yields on mortgage rates, you can make more informed decisions about the best time to secure a mortgage, helping to potentially reduce borrowing costs over the life of their loan.

As always, I am here to answer any mortgage related questions that you may have and help you crunch any numbers that you don’t quite understand - book a call here.