How Do Bond Yields Affect Interest Rates: Increase Your Mortgage IQ in 2 Minutes

How do bond yields affect fixed-rate mortgages?
Many factors affect the health of the economy such as unemployment rates, inflation, consumer confidence and real estate as just some examples.

The main factor that affects mortgage fixed rates is the Government of Canada's Bond Yields. A Bond Yield is a return an investor realizes on a bond.

Fixed-rate mortgage rates are usually in line with bond yields for the same term. For example, on Government bonds, the investor is guaranteed a certain yield or coupon for a certain amount of time. This is similar to when a borrower obtains a five-year fixed-rate mortgage and the rate stays the same for the entire five years.

The reason banks usually follow bond yields is that bonds and mortgages compete for the same investors such as those through mortgage-backed securities. Mortgages, however, usually make investors more money than bonds which is also why mortgage rates are always higher than bond yields.

When the stock market is booming, most investors do not take much interest in bonds since there are better returns elsewhere. Therefore, bonds remain cheaper and offer higher yields. In turn, banks raise their interest rates in line with rising bond yields.

When the economy is uncertain like it is today, investors flock to bonds because they are considered a safer investment vehicle. This pushes up the demand for bonds which drives the prices up and pushes yields down. In this situation, banks lower their interest rates in line with decreasing bond yields.

If you've been following the bond yield curve, you probably noticed that our bond yields have been going down lately. This is precisely the reason we have come to a time when our fixed mortgage rates are actually lower than our variable rates (which are governed by the overnight lending rate, not bond yields).

In some countries, the bond yield has moved into the negative which is why we have recently witnessed a Danish bank deposit a small interest payment into their mortgage borrowers' accounts to help pay for their mortgage.

It sure is a crazy time especially when not too long ago we were told the economy is great and interest rates will rise!

By: Sarah Colucci, Senior Mortgage Agent

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