Mortgage Rates Falling: A Rate War on the Horizon Soon?

On September 3rd, 2024, the Bank of Canada (BoC) lowered the overnight policy rate for the third consecutive time. In a recent press conference, Governor Tiff Macklem signalled that further rate cuts are likely in upcoming announcements. Despite these moves, the Canadian housing market has shown little response, as highlighted in a previous blog, largely due to a lack of buyer motivation. A major factor behind this was the stagnation in mortgage rates—until CIBC briefly lowered its insured 5-year mortgage rate to 3.99%.

This move sparked a ripple effect, with several major banks, including the Big Five, beginning to reduce their mortgage rates. As a result, many industry experts are now predicting a potential rate war. But how much truth is there to these speculations? Let's explore that now.

BEFORE WE BEGIN

Before diving into why mortgage rates are falling, it’s important to get familiar with a few key terms: bonds, bond yields, and the prime rate. Let’s break these down in the simplest terms.

Imagine you lend a friend $100 and say, "You can borrow this, but next month, you’ll need to pay me back $105." That extra $5 is the interest – the reward for lending money.

A bond works similarly. When you purchase a bond, you're lending money to a company or the government. In return, they promise to repay the principal (the original amount you lent) along with interest. The yield is simply the return or reward you receive for holding the bond.

On the other hand, the prime rate is like the starting point for all interest rates. When you apply for a loan, the bank doesn't randomly choose an interest rate. Instead, they use the prime rate as a baseline. This rate helps determine the interest rate you’ll get for mortgages, car loans, and credit cards.

If you have an excellent credit score, the bank might offer a rate slightly below the prime rate. If your credit isn’t as strong, they could charge a higher rate.

BOND YIELDS

So why should you care about bond yields and the prime rate? Because since March 2024, bond yields have been steadily declining, and most economists predict they will continue to drop.

Fixed mortgage rates are closely linked to government bond yields, especially the 5-year Government of Canada bond yield. When bond yields go up, fixed mortgage rates typically rise. When bond yields fall, fixed mortgage rates tend to drop as well.

While the relationship between bond yields and mortgage rates isn’t perfectly direct, there is a strong correlation. Usually, fixed mortgage rates are 1% to 3% higher than the related bond yield. For instance, a 5-year fixed mortgage rate is often set 1% to 3% above the 5-year Government of Canada bond yield.

Banks use bonds as a low-risk way to fund mortgages. When bond yields increase, banks may raise fixed mortgage rates to keep their profit margins steady—and when bond yields fall, like they are now, mortgage rates often follow suit.

PRIME RATE

In recent months, the prime rate in Canada has dropped significantly, largely due to the rate cuts by the Bank of Canada and falling bond yields. The most recent cut of 25 basis points brought the prime rate down from 6.70% to 6.45%. Following this move, major banks like RBC, BMO, TD, Scotiabank, and CIBC also lowered their prime rates to 6.45%.

These rate cuts are crucial because the prime rate directly influences variable mortgage rates. As the prime rate decreases, borrowing costs for mortgages, lines of credit, and other loans become more affordable, making it a favourable time for borrowers to secure better terms on their loans.

THE IMPACT: ONCOMING RATE WAR

Borrowers are now seeing insured 5-year fixed mortgage rates as low as 3.99%, thanks to a significant drop in bond yields, which have fallen by over 118 basis points since April. This decline in bond yields has prompted lenders—particularly the Big 5 banks—to fiercely cut rates in a bid to attract borrowers.

Currently, insured mortgage rates are 20 to 40 basis points lower than their uninsured counterparts. Banks like RBC, TD, and CIBC are offering discretionary rates below previous levels, with CIBC leading the charge as the first to offer 3.99% insured rates. This aggressive rate-cutting strategy is not only aimed at boosting mortgage originations but also at increasing market share.

In addition, banks often use mortgages as a gateway to sell other financial products, enhancing profitability through cross-selling. With competition heating up, more lenders are expected to join the rate war, offering 4% mortgage rates in the coming weeks or months.

This trend may continue at least until the banks close their fiscal year on October 31, though it could extend further depending on market conditions. Now may be a great time for borrowers to take advantage of these historically low rates before the market shifts again.

THE TIME IS NOW

The current trend in Ontario's real estate market reflects how declining mortgage rates have sparked increased buyer activity, leading to rising home prices. With the average price jumping by $20K in just two weeks and semi-detached homes experiencing the largest price gains, the momentum is undeniable. Our data shows a 2.3% increase in sales prices in early September, indicating that buyers are eager to take advantage of lower mortgage rates before prices climb further.

Rather than waiting for future rate cuts, which may lead to even higher property prices, now is the ideal time to act. By locking in a property while prices are still manageable, you position yourself ahead of the curve and avoid paying a premium down the line. So our advice is don’t wait—make your move while the market still presents favourable conditions.