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2 May

The banks’ tricks to raising rates


Posted by: Aneta Zimnicki

Recently there has been a lot of noise in the news about rising fixed mortgage interest rates.  Here are my insights why fixed mortgage rates go up.  My crystal ball is out for repairs, so I will do my best to give you some good context of how this all works to help you make your own assessment.

Firstly, it is important to note that fixed and variable rates depend on slightly different parameters.  In brief, the prime rate, which is the basis of a variable rate mortgage (in context, a variable rate mortgage offering is: prime plus/minus x%), is dictated by the Bank of Canada (BoC) ‘overnight rate’.  The BoC meets 8 times a year and sets this rate.  The ‘overnight rate’ is based on a number of factors, mainly on the economy, so if the economy is strong, the rate may go up.

On the other hand, fixed mortgage rates are primarily based on the Canadian government bonds yields.  This is the most basic explanation.  There are many more complex parts to this, but I will reserve the economics lesson for another post.  Let’s focus on some simple information for now.

Historically, bond yields and fixed mortgage rates tend to run in sync with each other.  If one goes up, the other goes up as well, for example.  Banks make a profit based on the ‘spread’ between the two measurables.  If the spread goes beyond a certain comfort level, that may signal a mortgage rate change.  This is the overall trend, but not always. In general, when the economy is booming, bond yield rises and signals a mortgage rate increase. Conversely, when the economy is bad, bond yield falls, so mortgage rates should decrease.

This is far from a perfect science.  Throw in politics, media, markets, acts of God and everything in between, you get more difficulty in predicting exact outcomes.   When was the last time we had all economists agree?

Beyond depending on the metrics noted above, I have seen banks raise rates for various reasons. 

We just saw in the news, a large retail bank increase their ‘posted rate’.  If you look beyond the headline, this is a lot about these banks making more money from penalty fees or retaining clients (because penalties are too high to justify changing lenders).  Most borrowers don’t get ‘posted rate’, but some sort of rate ‘discounted’ from the posted rate.  The deeper the discount, the more painful the penalty fees will be, in general.  (There are other lenders that are not ‘retail banks’ and don’t operate this way, see related blog post here).

Banks may raise rates in anticipation of borrowers wanting to lock in their variable rate.  This is usually cleverly timed with the scheduled Bank of Canada overnight lending rate announcements.

Banks may raise rates to signal or influence the government in a decision.  Like the overnight rate noted above.  It could become a self fulfilling prophecy.

Banks may raise rates in anticipation of upcoming renewals.  Currently this year there is a larger number of borrowers in this situation.  Combined with much tighter qualification rules, borrowers may have no choice but to take the mediocre offering.  Banks hope to collectively raise the government published ‘benchmark qualifying rate’, as a client retention strategy.

Banks may raise rates to test the waters, and see if their competitors follow suit.  It’s no secret that lenders are driven by profit.

Banks may raise (or lower) rates to funnel borrowers into the lender’s  preferred product.  For example, if lender wants longer term clients, they make the shorter term rates less attractive.  You may see ‘5 year specials’ that are a lower rate than some shorter terms.  Or, lenders position an unattractive variable rate offering so the fixed rate looks like a better deal.

Banks may raise rates to discourage applications if they are flooded with business  or want to limit certain type of borrower or risk. They turn taps off temporarily.  Examples can include restricting lending on rental property, business for self borrowers or refinances.  Or, lenders can choose to apply a premium to their basic rates for certain application types.

To sum it up, banks raise rates because they can.  Mortgage qualifying rules have tightened.  Many borrowers have less options and don’t have many other places to look.