Understanding the impact of Bank of Canada decisions on mortgage rates: Adjustable-rate vs fixed-rate
The Bank of Canada’s decisions regarding the policy rate have significant repercussions for the Canadian mortgage market. It is essential to understand how these decisions influence mortgage rates, distinguishing the direct impact on variable rates from the indirect impact on fixed rates.
Direct impact on variable mortgage rates
The Bank of Canada’s policy rate is the interest rate at which financial institutions lend each other money on a short-term basis. When it is changed, this adjustment typically reverberates immediately to the variable interest rates offered to borrowers. For example, a drop in the policy rate can lead to an equivalent reduction in variable mortgage rates, thereby lowering the monthly payments of the affected borrowers.
In January 2025, the Bank of Canada lowered its policy rate by 25 basis points, bringing it to 3%. This decision directly influenced variable mortgage rates, giving borrowers an opportunity to reduce their borrowing costs.
Indirect impact on fixed mortgage rates
Unlike variable rates, fixed mortgage rates are not directly tied to the Bank of Canada’s policy rate. They are primarily influenced by the yields on long-term Canadian government bonds and by market expectations regarding future interest rate movements. Thus, even if the policy rate changes, fixed rates can remain stable or evolve differently, depending on bond market conditions and economic expectations.
For example, a cut in the policy rate can signal the Bank of Canada’s intention to stimulate the economy, which can be perceived as a sign of economic slowdown. This perception can influence long-term bond yields, thereby affecting fixed mortgage rates. However, the magnitude and direction of this impact depend on various economic factors and market expectations.
Distinction between variable and fixed rates
It is crucial for borrowers to understand the distinction between variable and fixed mortgage rates in order to make an informed choice:
- Variable rate: These rates fluctuate with changes in the Bank of Canada’s policy rate. They typically offer lower initial interest rates but carry the risk of future rate increases, which can raise monthly payments.
- Fixed rate: These rates remain constant for the term of the mortgage. They offer payment predictability but may be initially higher than variable rates. Their evolution depends on long-term bond yields and economic expectations.
How to choose between fixed and variable rates?
The choice between a fixed rate and a variable rate depends on several factors:
- Tolerance for risk: If you prefer stability and predictability of payments, a fixed rate may be more suitable. If you are willing to accept potential fluctuations to benefit from lower initial rates, a variable rate could be appropriate.
- Economic expectations: If you anticipate that interest rates will remain stable or fall, a variable rate may be advantageous. If you anticipate rate increases, a fixed rate can offer protection against those rises.
- Term length: For short terms, a variable rate may yield savings if rates stay low. For longer terms, a fixed rate can provide protection against potential rate increases.
It is recommended to consult a mortgage advisor to assess your personal situation and determine the most appropriate option based on your financial goals and risk tolerance.