To understand what the Bank of Canada interest rate actually is, we have to define some terms. The interest rate being referred to when the BoC makes an announcement is the benchmark overnight rate. This value determines how much it costs Canada’s banks to borrow money from each other at the close of each business day.
Banks are always sending money back and forth between each other. Whether that is for Interac e-transfers, payments to businesses, to settle accounts and much more. To balance their books at the end of the day, banks have two options: they can borrow money from each other or from the Bank of Canada itself. The first option is subject to the overnight rate, and the second is subject to the much-less talked about deposit rate.
For the sake of simplicity, we’ll discuss the overnight rate in this article, as it gets the most coverage and has the most potential impact on the housing market.
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A lot of buyers are like, "I want the best rate; I want the best rate," but the "best rate" is not always the best outcome for them. There’s so much noise out there, but everyone’s financial situation is different from each other.
Terry Batth
Mortgage Broker at Bayfield Mortgage
How does the overnight rate impact mortgage rates?
The overnight rate does impact mortgage rates, but it’s a little more complicated than it seems. Depending on whether you have a fixed or variable rate mortgage, the BoC’s interest rate announcement will affect your mortgage in different ways.
Variable rate mortgages.
Lenders set their variable rate mortgages’ interest rate based on the BoC’s overnight rate. That means if there’s a rate cut, your mortgage’s interest rate goes down and if there’s an increase your mortgage’s interest rate goes up.
Depending on the payment plan you have in place, this could either mean your payments go up if the BoC increases rates, or a greater portion of your payment goes toward interest, rather than principal. If there’s a cut, your payments could go down or you might pay more toward the principal. Ask your mortgage broker or lender to be sure.
Fixed rate mortgages.
The impact of the BoC’s interest rate announcements is less direct on fixed rate mortgages than variable rate mortgages. After all, as the name suggests, your interest rate is fixed at a certain value and won’t change until it is time to renew your mortgage.
But for new borrowers, or if it is time to renew and you’re considering another fixed rate mortgage, the BoC’s interest rate announcements will affect fixed mortgage rates in a more roundabout way.
That’s because fixed rate mortgages are tied to the bond market. The bond market is where bonds, or promises by an issuer to pay money to the holder of the bond, are traded. In this case, it’s the government issuing the bond. Lenders use five-year bond prices to set their fixed rate mortgage rates.
If the BoC cuts rates, it means inflation is going down which increases the value of the bonds investors are holding, and that also means more people buy bonds. All of this leads to the decrease in bond yields, which helps push down fixed rates.
If the BoC raises rates, the opposite happens. As a result, fixed rate mortgages go up.
Overall, fixed rate mortgages’ interest levels tend to lag a bit behind whatever the market is doing. For those looking to buy a home with a fixed rate mortgage or renew a fixed rate mortgage, the most immediate BoC announcement won’t have much effect on them, but the overall economic story could affect them a few years down the line.
What should I do in response to a BoC rate announcement?
It may be tempting to react immediately to whatever the most recent Bank of Canada interest rate announcement is, but resist the urge to act without thinking.
“I always tell customers to be aware of the rate, but more importantly pay attention to the actual dollar amount they’ll pay. Yeah these rate fluctuations, they’re always going to be there. Instead, look at the amount you have to pay at the end of the month,” says Terry Batth, a Mortgage Broker at Bayfield Mortgage. “A lot of buyers are like, ‘I want the best rate; I want the best rate,’ but the ‘best rate’ is not always the best outcome for them. There’s so much noise out there, but everyone’s financial situation is different from each other.”
Therefore, get in touch with a mortgage broker who can help explain what has happened and if it means anything for you. If you currently hold a variable rate mortgage, as mentioned, you will see an impact on your interest payments. Let your mortgage broker know you hold a variable rate mortgage so they can help guide you through the next steps.
For fixed rate mortgage holders, you have less to worry about in the immediate future, unless you are coming up on a renewal or are considering a switch to a variable rate mortgage.
If you are considering buying a home after a BoC rate announcement, remember that it will matter most to you if you go for a variable rate mortgage – but you will still have to qualify in the first place. BoC rate announcements don’t directly change the qualification criteria lenders use. You still have to show sufficient income, savings, employment records and other supporting documentation.
To determine how much you may end up paying, you can enter the details into REW’s Mortgage Calculator. Simply enter the price of the home, the down payment amount you have available, some details about yourself and the property – such as whether you are a first-time buyer or if it’s a newly built home – whether you’re considering a fixed or variable rate mortgage and its interest rate and your amortization period. The calculator will then tell you your estimated monthly mortgage payments. You can even enter your estimated monthly bills to determine how much you’ll be paying in total every month.
Whether you are looking to renew your mortgage, buy a home or just considering stepping into the property market for the first time, REW’s Money partners are ready to help.
