What Determines Mortgage Rates in Canada?

The Bank of Canada and Its Policy Interest Rate

The Bank of Canada plays a central role in shaping mortgage rates, but it does not set them directly. Instead, the Bank's policy interest rate—a target for the overnight rate—influences the cost of borrowing across the economy. When the Bank raises or lowers this rate, lenders typically adjust their prime rates, which in turn affect variable mortgage rates.

Changes in the policy rate are a signal to the market about the Bank's view on inflation and economic growth. While fixed-rate mortgages are not directly tied to the policy rate, they respond to expectations of future policy moves, often through bond yields.

Sources: Bank of Canada, Nesto

Bond Yields and Lender Funding Costs

Fixed mortgage rates are heavily influenced by Government of Canada bond yields, particularly the yield on bonds with a term similar to the mortgage term. Lenders use these yields as a benchmark for their own funding costs, so when bond yields rise, fixed mortgage rates tend to follow.

Lender funding costs go beyond bond yields. Lenders also factor in their operational expenses, the cost of capital, and the risk of default. These costs are bundled into the rate you pay, so variations in funding conditions can cause rates to differ between lenders and over time.

Sources: Nesto

Economic Indicators and Inflation

Inflation is a key driver of interest rates. When inflation is high, lenders and bond investors demand higher yields to compensate for the erosion of purchasing power. This pushes bond yields up and, consequently, fixed mortgage rates.

Economic growth also matters. Strong growth can lead to higher demand for credit and higher inflation expectations, which typically push rates upward. Conversely, weak growth or a recession may prompt the Bank of Canada to lower its policy rate, which can lead to lower variable rates and softer fixed rates.

• High inflation generally leads to higher mortgage rates.
• Economic growth influences demand for credit and inflation expectations.
• The Bank of Canada's policy rate is a response to economic conditions.

Sources: Bank of Canada, Nesto

Fixed vs Variable Rate Drivers

Fixed mortgage rates are tied to bond yields, as described above. They offer predictability: your rate stays the same for the term, regardless of market fluctuations.

Variable mortgage rates are more directly tied to lender prime rates, which move in response to Bank of Canada policy rate decisions. When the Bank changes its policy rate, variable rates typically adjust accordingly. This means variable rates can go up or down during your term, depending on the Bank's moves.

Sources: Bank of Canada, Nesto

Personal Factors: Credit Score, Down Payment, and Property Type

Your personal financial profile influences the rate you are offered. A borrower with a good credit history is seen as lower risk and may receive a lower mortgage rate. Down payment size also plays a role: a larger down payment, typically 20% or more, reduces lender risk because it changes the loan-to-value ratio and may affect whether you need mortgage default insurance. The relationship between down payment size and the offered rate can vary by lender and market conditions.

Lender policies on property type can also influence the rate you are quoted, though specific practices vary from lender to lender. Your best approach is to discuss your situation with potential lenders to understand how your personal factors affect the rate you qualify for.

Sources: Government of Canada, Nesto

How Lender Competition and Discounts Affect Rates

Lenders compete for your business, and this competition can influence the rate you pay. Lenders may trim their profit margin, known as the spread, to win more borrowers. This is why you may see different rates from different lenders for the same mortgage product.

This competitive pressure means the rate you are offered can depend on market conditions and the lender's business strategy. Shopping around and comparing offers can help you secure a rate that reflects current market conditions, though the actual rate you qualify for will still depend on the broader factors discussed above.

Sources: Nesto