Mortgage rates dropping due to cheap bonds

A strong international demand for bonds from Canada's biggest banks is trickling through the system and pushing mortgage rates to record lows at the consumer level.

BMO, TD lower some fixed rate offerings to 2.99%

People view properties advertised for sale in the window of a real estate agency in 2009. Low borrowing costs for banks are translating into falling mortgage rates. (Stephen Hird/Reuters)

A strong international demand for bonds from Canada's biggest banks is trickling through the system and pushing mortgage rates to record lows at the consumer level.

The Bank of Montreal moved its five-year fixed mortgage rate to 2.99 per cent late Thursday — the lowest posted rate from a major bank in Canadian history.

BMO announced the rate cut late on Thursday and TD followed suit by lowering their four-year fixed rate to 2.99 per cent on Friday afternoon. 

BMO's offer, which ends Jan. 25, states that lump sum payments are limited to 10 per cent of the principal each year. The mortgage is also based on a 25-year amortization period. TD's offer is open until Feb. 29, 2012. It's also for a four-year term, much less common than the standard five-year.

Other banks are expected to follow suit. On Wednesday, Toronto-Dominion Bank reduced its posted six-year rate 132 basis points to 3.79 per cent and lowered the posted seven-year fixed rate 91 basis points to 3.99 per cent.

Access to capital

Borrowers can often negotiate a better rate from a bank based on their credit history, but the posted rate at a bank is seen as the benchmark for its mortgage offerings. The five-year rate is by far the most common term for a first-time homebuyer.

Fixed rate

  • A fixed-rate mortgage features an interest rate that is fixed for a specific period of time, such as five years.
  • During this period, also known as the term, the mortgage interest rate will not change even if prevailing interest rates do.
  • The penalty for breaking a fixed-rate mortgage before the end of the term can be substantial – especially if the difference between your mortgage’s interest rate and current rates is large and there are several years remaining in the mortgage term. 

Variable rate

  • A variable-rate mortgage features an interest rate that floats with any change in the prime interest rate.
  • Depending on the lender, the mortgage payment may stay the same even if the prime rate changes, but the actual interest charged will change. So if the prime rate rises, less of the payment will go to the principal and more to interest.
  • Most variable-rate mortgages allow borrowers to switch to a fixed-rate mortgage at any time.
  • The penalty to break a variable-rate mortgage is usually three months interest.

Lower mortgage rates are the results of a broader trend in which international bond investors are gobbling up Canadian offerings at record levels because they're generally perceived as being safer than bonds from other countries.

"It's not surprising given that mortgage rate declines have actually been lagging behind falling bond yields," Queens University real estate expert John Andrew said. "[It's] driven by global economic uncertainty."

Earlier this month, BMO was able to sell $1.5 billion worth of five-year bonds at a rate of 2.544 per cent. Contrast that with the government of Italy, for example, which sold an offering of bonds with a 4.83 per cent yield on Friday.

Essentially, the bond market considers BMO a better bet than Italy. A lower yield is a sign investors have more confidence in that lender's ability to live up to the terms of the loan.

"Right now Canada is a function of what's happening in the global environment," Mark Kerzner of The Mortgage Group said. "And mortgage consumers are able to benefit from the noise in the rest of the world."

As Europe's debt crisis unfolds, investors are fleeing for safety. Canada is seen as a beacon in the financial world, so bond offerings from Canada's biggest lenders are in strong demand. Cheaper borrowing for the banks has in turn allowed them to seek new customers by cutting their consumer rates.

'Mortgage consumers are able to benefit from the noise in the rest of the world'—Mark Kerzner of The Mortgage Group

"There's a risk premium," said Nick Mitskopoulos, president of mortgage broker Verico Mortgage For Less in Toronto. "The three-to-five year money is cheaper [but] their short term costs have gone up."

"Their cost of capital is going up for the short term, but not for the long term."

Mitskopoulos said other lenders will be hard-pressed to match BMO's rate, although most will likely lower their rates a bit to compete. At that level, he suggests, BMO might be at a break-even level and is hoping to make gains from new customers through lines of credit.

Fixed-rate mortgages are closely tied to what's happening in the bond market, as that's how the banks finance their lending. Variable rate mortgages are more closely linked to the Bank of Canada's rate.