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How Fixed and Variable Rates Are Determined By The Lenders

Interest rates are a very big topic on the minds of many, especially when it comes to a mortgage. However do you really know how interest rates are determined by the lenders? This newsletter will explain the factors examined when determining interest rates.

How are fixed rates determined?

One misconception about fixed mortgage rates is that they move up and down accordingly to the Bank of Canada’s overnight rate or the lenders prime rate. In reality the prime rate is not used to determine fixed mortgage rates at all. Lenders use the Canadian bond market yields to determine the fixed mortgage rates offered. Meaning, if the bond market yields start to increase the fixed mortgage rates will also increase and conversely decrease when the bond yields decrease. So to know where fixed rate mortgages are, heading you need to know what is happing in the bond market. Bond yields are determined on demand for bonds. The reason why current fixed mortgage rates are low is because bond demand is high and yields are also low. Bond yields are currently low because many investors are buying bonds creating a high demand which lowers the yield. Bond demand is higher when money transfers from the equity markets to the safer bond market which usually happens during mor e uncertain economic times or recessions. As the equity market demand picks up money starts shifting away from the bond market (lowering the demand), thus the yields start to increase which effectively increases fixed mortgage rates.

How are variable rates determined?

Variable rates are directly reflected by what the Bank of Canada’s overnight rate and lenders prime rate are set at. The Bank of Canada does not set the prime rate but the lenders usually adjust their prime rates when the Bank of Canada changes the overnight rate. This means today with the overnight rate and prime rate not being able to move down any further that variable rate mortgages have nowhere to go but increase in the future.

Source: YourMortgageContact Newsletter(Feb 2nd, 2010)