Understanding Fixed Rate Mortgage Pricing

Most days, one of the first conversations I have with my colleague Jeff, usually starts out with ‘ What’s the yield doing today? ‘ This is the starting point of understanding fixed rate mortgage pricing.

Most mortgage brokers are as obsessed with 5 year bond yields as we are about when the Bank of Canada is going to move the Overnight Rate.

Why are we focused in the bond yields? Well, we use it to forecast what fixed rates are going to look like when we send that new purchase application in.

In a typical stable rate environment, we can make an educated guess as to what fixed rate we’ll be able to get and what will be considered a good rate versus a bad rate.

Five year fixed rates are based on the 5 year bond yield plus 1.7%. Where does the 1.7% come from? The bond yield is of course, the cost to the lender for the funds they’ll lend out. The 1.7% or ‘spread’ is where their costs and their profit will baked in.

So, if we look at today’s bond yield of 3.34% and add the 1.7% ( the ‘spread’ ) - hey presto, we get a ‘good’ 5 year rate of 5.04%.

It’s understood that the 5.04% is a starting point, what comes out as the actual rate will factor in additional risks ( conventional financing rather than insured for example ) and most importantly, the supply of funds available to lend.

For the last few months, bond yields have been as much as 50 basis points (.5%) higher than they are now but lenders have held rates low, because there are fewer people borrowing and left more cash available to lend. In a ‘normal’ market when we see the sudden recent drops in the bond yield that we have recently, we should see rates drop as well.

Instead, because the spread was compressed before ( a purposely lower profit margin ), none of the lenders are leaping to make discounts on their rate today, in order to recoup some of the losses from the previous months.

Ultimately, this is why it’s so important to use a mortgage broker to negotiate the best rate for your purchase, renewal or refinance or simply to understand why rates are what they are.