Changing Bond Yield
On Saturday highest reported yield was 1.54% for Canadian government five years bond. Last month on 24th the yield was at 1.12%. This was more than one-third increase in less than a month.
Bond yield has potential to influence many related returns, specially our fixed mortgage interest rate.
The Effect on Mortgage Rate:
A higher bond yield generally drives the fixed mortgage interest rates. Therefore a raising bond yield indicates a future rate raise in the mortgage world.
Before pushing the rates up, there are few buffers a lender can use.
A healthy spread of 180bps between the 5 year yield and real mortgage rate was there before the yield started to move up. Historically this spread used to be lower than the present. So, we can assume the lenders still have some room to play.
Lenders can start to cut back on product frills. Mortgage Frills are like goodies which come with your loan. Things like mortgage vacation, prepayment options etc. Every special add-on cost a lender money. Therefore if they start to cut back on those they can save their rate.
There are lenders who started to cut back on brokers commissions and reward points. By doing this they are justifying the decision to maintain the low rate.
Lenders may see their prepayment penalty revenue disappear. If you have a fixed rate mortgage then you pay penalty to break the mortgage. More than 50% Canadians break their mortgage early.
The penalty is generally higher of three months interest or interest rate differential. If the mortgage interest rate goes above the IRD calculation rate then they have to stay happy with three months interest rate. This fact will add some pressure on lenders to increase rate or find a way. Often they use the bloated posted rate to calculate the differnnce – in that case they will get the IRD.
Bottom Line:
With the fierce rate competition it is unlikely that any lender will move from its position very fast.
If the yield continues to stay above 1.5% then the banks will eventually be forced to kick rates up.
Another factor is lower HELOC limit. The lower limit will put some stagnant cash in banks pocket. They will try their best to use that money. In a matured market, probably rate is the best bet.
