Government Bond Yields and Your Fixed Rate Mortgage

Fixed Rate Mortgages are at extremely low levels right now and we are receiving a high volume of inquiries from homeowners who are looking to refinance their existing mortgages to take advantage of the low fixed rates available.

We thought it would be a good time to explain why mortgage rates are so low and what factors influence them.

First let's start off with a relationship:

The Canadian Mortgage and Housing Corporation (CMHC) insures mortgages in Canada. CMHC is a Crown Corporation, which means that it is insured by the Canadian Government.

This means that mortgages have a Government guarantee just like Government of Canada Bonds.

So why is your mortgage rate higher than a Government of Canada Bond?

There are two additional costs associated with mortgages that are not associated with Government of Canada Bonds. The first is the risk that the client will repay their mortgage. The second and more important risk is the perceived risk premium associated with mortgages.

Bond Yields

The Government of Canada sells bonds, these bonds are priced with an interest rate that the Government feels is adequate to compensate the lender of the funds for the amount of time that they have decided to part with their money for.

In increase in Bond Yields means that investors are not willing to pay as much for bonds as they used to.

** note, the yield of a bond can only increase when the price you pay for the bond decreases, if a bond costs $100 and pays interest at 4% annually ($4.00) and you buy the bond for $100 your yield on the bond is 4%.

If you pay $95 for the same bond your yield is now 9% (your $5.00 in savings) + $4.00(the interest payment).

In this market it would be plausible to expect that investors would begin to demand a higher rate of return on their money even though it was backed by the security of the Canadian Government since there are alternative investments with risk return propositions that are enticing or more efficiently priced. As the economy staggers back to a more stable footing we will see these bond yields increase, although through Quantitative Easing methods a central bank can manipulate these risk free rates of return.

Bond Yields and Mortgage Rates:

A comparison of Canadian Bond Rates and Mortgage Rates with equal maturities reveals that mortgages are typically priced 1% higher than Canadian Bond Yields. This however does not always hold true. Currently mortgage rates are at least 2 % higher than Government of Canada Bonds. This increase in the premium over bonds is a result of the weakened credit markets. At the height of the crisis mortgages traded at a 4% premium to Government of Canada Bonds.

When the economy begins to stabilize, people become more confident in the market and no longer flock to the risk free returns of Government Bonds. As the demand for these bonds decreases their prices must decrease to increase the yield or return available to the purchaser.

Economic stability will bring a reduced risk premium associated with mortgage debt, so it stands to reason that although Government of Canada Bonds will be increasing in yield the premium associated with mortgage debt will be decreasing.

Since the exact impact of these factors can not be measured it might be a good time to lock in a low five year fixed rate mortgage. We believe that his will serve our clients well in an uncertain environment with such historically low rates.

Please free to contact us with any questions 416-214-9000.