Rate Drops After Approval
When you’re approved for a mortgage your lender agrees to hold your interest rate for a set period of time.
Rate holds are usually either: 120-days, 90-days, 60-days, 45-days, or 30-days.
When you have a long rate hold, much can change before you close. Odds are, rates on your closing date will be different from the rate you received when applying.
If rates go up, you’re laughing because your rate hold protects you.
If rates drop, you’ll want to make sure your bank or broker is watching out for you and secures you the lowest rate possible.
Different lenders have different policies on rate adjustments. Here are a few examples:
Rate Fixed Before Closing: Some lenders will adjust your rate lower (if applicable) at a set number of days before closing--like 5 or 7 days. This means you have to wait until that date to make any adjustments. If rates drop and then go back up before this date, you don’t benefit from those previously lower rates.
Broker-Instructed Rate Locks: Some lenders give brokers a chance to re-lock their client’s rates at any time between approval and closing. The broker usually gets one shot in this case, so timing is everything.
Rate Lookbacks: Hindsight is 20/20, and this is one of the few cases where you benefit financially from it. Rate lookbacks are the best of all rate drop policies because they require no timing. The lender simply offers you the lowest rate they’ve had between your approval and closing dates. ING and MCAP are two examples of lenders offering this policy.
Other things being equal, choosing a lender that offers rate lookbacks will save you money over the long-run, especially if you have a 90 or 120-day rate hold.
Remember as well that some lenders require broker intervention to arrange for a rate drop. Other lenders simply drop your rate automatically at their specified rate adjustment date. Always ask your mortgage planner how the lender you’ve chosen works in this respect.
Friday, March 27, 2009
Thursday, March 19, 2009
Massive Decline in Bond Yields
Canada’s 5-year bond yield had a huge drop today—it’s largest 1-day fall since September.
The yield on the 5-year Canada now stands at 1.70%, a 2-month low.
The unusual move came after the U.S. Fed announced it would buy over $1 trillion of fixed-income securities in the open market. Analysts say that is tantamount to the Fed admitting there is no bottom in sight for the American economy. (More on this at CEP)
Bond traders--who put their money where their mouth is when predicting rates--never saw this coming.
Many were caught short and had to cover in panic fashion. Yields dropped like a rock as a result.
This, of course, is great news for people on the hunt for a good fixed mortgage rate. (Bond yields generally lead fixed rates.) So far we’ve heard of two lenders talk of lowering their rates. We’ll have to wait and see what happens over the next 3-4 days.
The yield on the 5-year Canada now stands at 1.70%, a 2-month low.
The unusual move came after the U.S. Fed announced it would buy over $1 trillion of fixed-income securities in the open market. Analysts say that is tantamount to the Fed admitting there is no bottom in sight for the American economy. (More on this at CEP)
Bond traders--who put their money where their mouth is when predicting rates--never saw this coming.
Many were caught short and had to cover in panic fashion. Yields dropped like a rock as a result.
This, of course, is great news for people on the hunt for a good fixed mortgage rate. (Bond yields generally lead fixed rates.) So far we’ve heard of two lenders talk of lowering their rates. We’ll have to wait and see what happens over the next 3-4 days.
Friday, March 6, 2009
How Canadian mortgage rates are set
There seems to be a some confusion about how mortgage rates are set in Canada. Every time the Bank of Canada announces a change to its target for the overnight rate (formerly the bank rate), I get calls about the latest changes to mortgage rates. I try to explain to them that there is no correlation between changes in the overnight rate and changes in mortgage rates.
Fixed residential mortgage rates are determined by changes in the bond market and the competitiveness of the chartered banks in Canada. The Bank of Canada has very little, if any, influence on them.
A great example of this was the rate change by the Bank of Canada on April 13, 2004. The Bank announced it was lowering the overnight rate by one quarter of 1%. The average consumer thought that this would mean that mortgage rates were going down when in fact mortgage rates were rising. (The 5-year fixed rate jumped by more than one half of 1% around this same time and it continued to rise in May.) If you compare changes to the overnight rate with mortgage rate trends, you will notice that sometimes mortgage rates went up, sometimes they went down and sometimes they stayed the same, regardless of which way the overnight rate was adjusted.
The chartered banks set their mortgage rates based on yields in the bond market.
A Government of Canada bond represents a risk free investment to the banks. If the banks choose to invest in a mortgage, they are taking on added risk and incurring costs to set up and service it. The banks will set their mortgage rates high enough above the equivalent bond yield to cover their costs and provide some sort of profit margin for the added risk they are taking on. Over the past decade the spread above the equivalent bond yield has narrowed as the competition for mortgage business has intensified between the big banks.
As an example, a 5-year Government of Canada bond is yielding about 4.00% today and most 5-year discounted mortgage rates are set at about 5.20%. This means that the chartered banks are only earning a risk premium of 1.20% before expenses.
So now you might be asking, how are bond yields determined? By investors' expectations for interest rates in the future. These expectations are arrived at by assessing the state of the Canadian economy and predicting where it is headed relative to other world economies. There is no science to such predictions (although some economists spend a lot of time trying to make it into a science). At best the markets make their best guess and keep updating their guess every day.
My suggestion to anyone who wants to predict when mortgage rates will rise and fall is to track Government of Canada bond yields daily. Most financial papers list the bond yields for various terms each day. It is normal for yields to change slightly from day to day, but if you start to see consistent increases or decreases then you can expect that the banks will be adjusting their mortgage rates accordingly. If you are interested in a 5-year mortgage rate then track the equivalent 5-year Government of Canada bond; if you are interested in a 1-year mortgage rate then track the equivalent 1-year Government of Canada bond, and so on.
Now that I have told you that the Bank of Canada does not have an impact on mortgage rates, there is one exception to this rule. Most variable rate mortgages are affected by changes to the prime rate as set by each of the chartered banks. The prime rate will change, in the same direction and by the same amount, as any change to the overnight rate. So if the Bank of Canada announces a decrease in the overnight rate by one quarter of 1% (or "25 basis points" in financial parlance), then you can expect most variable rate mortgages to also drop by one quarter of 1%.
So unless you have a variable rate mortgage, don't pay attention to the hype surrounding interest rate announcements by the Bank of Canada. If you want to know where fixed rate mortgage rates are headed, follow changes in the bond market.
Summary:
The BoC sets Canada’s overnight target rate. This in turn influences prime rate, which directly affects variable rates.
Fixed rates are usually driven by bond yields. The Bank of Canada has no direct control over bond yields, although it can influence them in certain ways.
Fixed residential mortgage rates are determined by changes in the bond market and the competitiveness of the chartered banks in Canada. The Bank of Canada has very little, if any, influence on them.
A great example of this was the rate change by the Bank of Canada on April 13, 2004. The Bank announced it was lowering the overnight rate by one quarter of 1%. The average consumer thought that this would mean that mortgage rates were going down when in fact mortgage rates were rising. (The 5-year fixed rate jumped by more than one half of 1% around this same time and it continued to rise in May.) If you compare changes to the overnight rate with mortgage rate trends, you will notice that sometimes mortgage rates went up, sometimes they went down and sometimes they stayed the same, regardless of which way the overnight rate was adjusted.
The chartered banks set their mortgage rates based on yields in the bond market.
A Government of Canada bond represents a risk free investment to the banks. If the banks choose to invest in a mortgage, they are taking on added risk and incurring costs to set up and service it. The banks will set their mortgage rates high enough above the equivalent bond yield to cover their costs and provide some sort of profit margin for the added risk they are taking on. Over the past decade the spread above the equivalent bond yield has narrowed as the competition for mortgage business has intensified between the big banks.
As an example, a 5-year Government of Canada bond is yielding about 4.00% today and most 5-year discounted mortgage rates are set at about 5.20%. This means that the chartered banks are only earning a risk premium of 1.20% before expenses.
So now you might be asking, how are bond yields determined? By investors' expectations for interest rates in the future. These expectations are arrived at by assessing the state of the Canadian economy and predicting where it is headed relative to other world economies. There is no science to such predictions (although some economists spend a lot of time trying to make it into a science). At best the markets make their best guess and keep updating their guess every day.
My suggestion to anyone who wants to predict when mortgage rates will rise and fall is to track Government of Canada bond yields daily. Most financial papers list the bond yields for various terms each day. It is normal for yields to change slightly from day to day, but if you start to see consistent increases or decreases then you can expect that the banks will be adjusting their mortgage rates accordingly. If you are interested in a 5-year mortgage rate then track the equivalent 5-year Government of Canada bond; if you are interested in a 1-year mortgage rate then track the equivalent 1-year Government of Canada bond, and so on.
Now that I have told you that the Bank of Canada does not have an impact on mortgage rates, there is one exception to this rule. Most variable rate mortgages are affected by changes to the prime rate as set by each of the chartered banks. The prime rate will change, in the same direction and by the same amount, as any change to the overnight rate. So if the Bank of Canada announces a decrease in the overnight rate by one quarter of 1% (or "25 basis points" in financial parlance), then you can expect most variable rate mortgages to also drop by one quarter of 1%.
So unless you have a variable rate mortgage, don't pay attention to the hype surrounding interest rate announcements by the Bank of Canada. If you want to know where fixed rate mortgage rates are headed, follow changes in the bond market.
Summary:
The BoC sets Canada’s overnight target rate. This in turn influences prime rate, which directly affects variable rates.
Fixed rates are usually driven by bond yields. The Bank of Canada has no direct control over bond yields, although it can influence them in certain ways.
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