Understanding mortgage rates is key to making informed decisions about home financing. Our infographic breaks down the types of mortgage rates—variable and fixed—while also exploring what impacts mortgage rates, from the prime lending rate to bond yields. We’ll also take a closer look at what influences overnight rate changes and bond yields, such as inflation, GDP, and unexpected events, to help you understand how economic factors shape borrowing costs.
Mortgages: A mortgage is a loan used to buy a home where the home itself acts as collateral until the loan is repaid. |
| Variable Rate A variable rate mortgage means the amount of interest you pay throughout your loan term fluctuates depending on what the current prime rate is. | Fixed Rate A fixed rate mortgage means the interest rate you pay stays the same throughout the entirety of your mortgage duration. |
| What impacts it: prime lending rate Variable mortgage rates are positively correlated to the prime lending rate, which is the interest rate banks use for their loans. The prime lending rate is directly impacted and positively correlates to the Bank of Canada’s overnight rate, which is the interest rate the central bank charges commercial banks for short-term loans and reflects the short-term cost of borrowing and the health of the economy. When the overnight rate goes up, the prime rate also rises, causing variable mortgage rates to increase, which means you pay more in interest. | What impacts it: bond yields Fixed mortgage rates are positively correlated to government bond yields, especially 5-year bonds, because these yields reflect the long-term cost of borrowing and the economic outlook. When bond yields rise, fixed mortgage rates typically increase so lenders can cover higher borrowing costs — which means you’ll pay more interest on your loan. |
| What influences overnight rate changes The Bank of Canada (BoC) announces rate changes on 8 fixed dates a year to combat inflation. Whether it increases or decreases can depend on several factors: Inflation: The BoC tries to keep inflation at its 2% target. Raising rates help slow spending and borrowing when inflation is high, while lowering rates can stimulate activity when inflation is too low. GDP: The BoC considers the size of the economy when setting rates. High GDP can signal inflation risks, prompting rate increases to prevent overheating. Low GDP may indicate unused capacity, leading to rate decreases to stimulate activity. Economic growth: Strong economic growth can lead to higher interest rates, as demand for goods, services, and loans increases. If growth is slow or stalled, the BoC may lower rates to stimulate the economy. Geopolitics: International events, like economic slowdowns abroad, trade issues, or conflicts, can impact Canada’s economy and lead to rate adjustments as the BoC attempts to mitigate these impacts. Unexpected events: Natural disasters, supply chain shortages and pandemics can cause the bank to lower rates in support of recovery efforts. Labour Markets: The BoC adjusts rates to balance job creation and economic activity. Lower rates encourage business expansion and hiring, while higher rates can help prevent an overheated job market. | What influences bond yields Bond yields reflect the return investors earn from a bond, whether it increases or decreases can depend on several factors: Overnight rate: When central banks raise interest rates, newly-issued bonds offer higher yields, making existing bonds with lower yields less attractive. Their prices drop to compete with the new, higher-yielding bonds, pushing up yields on existing bonds. Inflation expectations: If inflation is expected to rise, bond yields generally increase because investors demand higher returns to keep up with the decreasing purchasing power of future bond payments. Economic growth: Strong economic growth can signal inflation risks and tighter monetary policy, leading to higher yields. In contrast, weak growth or recession fears increase demand for safe assets like government bonds, driving yields lower. Geopolitical/Unexpected Events: Crises or geopolitical instability drives investors to purchase government bonds due to their safety, which raises demand and prices of bonds, lowering yields. Supply and Demand: Like with most investments, supply and demand significantly impact their prices. When demand for bonds rises, prices go up, and yields fall; when demand drops, prices fall, and yields rise. Similarly, an increase in bond supply can lower prices and raise yields, while limited supply can push prices higher and yields lower. |
Why is the prime rate higher than the overnight rate?
The overnight rate is what banks pay to borrow money from each other or the central bank, so it’s essentially a “wholesale” cost. The prime rate is higher than the overnight rate because banks need to cover their own costs and make a profit on loans.
Interested in seeing the history of previous overnight rates? Check out this page! https://www.ratehub.ca/prime-mortgage-rate-history
