Mortgage rates are becoming a harsh reality for folks, so I thought it might be helpful to break them down so you can have a little more context about them.
Where do these rates come from? Mortgage rates are tied to bond markets, where mortgages are bought and sold, and they are financed with GICs (Guaranteed Investment Certificates.) There’s two sides to this then:
How much a bank can sell your mortgage for after they’ve bundled them up with others into a Mortgage Backed Security, which then competes with other bonds.
What a bank can competitively offer a GIC for. Banks compete for the money to fund their mortgages with, ideally they want to offer the lowest GIC rate, but they need to be competitive with the banks around them.
The difference between what they pay for money, to a GIC holder, and what they make, from mortgage interest is how much profit they can expect to make on each mortgage. This is called the spread.
The process to create a mortgage backed security (MBS) isn’t instant, a bank knows they’ll be holding these mortgages for a bit. They want to reduce their risk, so in times of volatility, such as when rates are rising quickly, they may even push their mortgage rates higher so that they have some wiggle room before they can sell them.
This can end up pushing mortgage rates higher.
Mortgage rates also need need to be competitive with government bonds, which they are often characterized as being similar in risk to. The majority of mortgage backed securities are guaranteed by their respective government so they present a similar level of risk then a government’s debt itself, but can be found with a higher yield, or interest rate.
The reason they need to compete is that banks lend out at a multiple to the capital they have on hand. For every dollar they have deposited, they may have lent out, 10, 20, or even 30 dollars on that deposit.
When money is lent out in the form of a mortgage a bank wants to recuperate that capital so they can lend out to the next mortgage borrower. Selling these mortgage backed securities allows a bank to reacquire the cash they need to lend again.
So there’s more then just what a central bank is doing to overnight interest rates that affects mortgage rates. It’s a complex ecosystem that fits within the overall debt market. This is why mortgage rates can move so quickly, and why it’s often difficult to predict where they’ll go.
This is why it’s important to make sure any mortgage product you buy fits your needs and purpose. For my information on how to make the most of your mortgage, have a listen to the episode on it below.
https://anchor.fm/letstalkaboutitfinance/episodes/Lets-Talk-About-Debt–Mortgages-and-Home-Prices-e1jb0np