Mortgage rates are influenced by several economic factors, including inflation. When inflation is high (as it currently is at the time of writing) mortgage rates tend to rise in response to this. This happens for several reasons:
Inflation erodes purchasing power. Meaning that the same amount of Canadian dollars today can buy fewer goods and services than it was able to purchase yesterday. Banks and investors are less willing to lend money at lower fixed interest rates during inflationary times, as the value of the money they receive in the future is likely to be less than the rate of inflation. (For example, if the bank lends money at a rate of 3.00% per year, but inflation is a whopping 6.00%, they are losing money on their investment as inflation is eroding their return). To ensure they remain profitable, Banks compensate for this uncertainty by charging higher mortgage rates.
Inflation can lead to higher borrowing costs for banks. When the bank’s borrowing rates go up, they then can pass on those costs to borrowers in the form of higher mortgage rates (and other loan rates). When inflation is high, central banks will raise short-term interest rates to curb inflation, leading to higher borrowing costs for the banks too. If this is confusing, it’s important to know that the banks also borrow money. Just like the loans we have; the Banks have loans that are also increasing in interest as the Bank of Canada increases rates.
Inflation can lead to higher demand for most loans, including mortgages. As the cost of goods and services increases, homeowners may seek to borrow even more money to maintain their standard of living or invest in other types of assets. Higher demand for loans (especially during inflationary periods) can put upward pressure on mortgage rates as well. Banks and Lenders respond by raising rates to manage their funds supply and attract investors. Raising rates is also a deterrent to borrowing money, which reduces market liquidity (this is called quantitative easing). In other words, the less money available to spend, the less demand there is for goods and services – the less demand, the lower prices should fall, thus reducing the rate of inflation.
As Canada Bonds increase, so do fixed mortgage rates. You might not know this, but fixed mortgage rates are tied to Canadian Bond Yields. Canada Bonds are virtually zero risk, so if the banks want to continue securing investors, they have to offer fixed rates that are more attractive than bonds – otherwise, why would an investor put their money in the riskier mortgage market, when they can earn the same return on a zero risk investment like bonds?
In conclusion, mortgage rates are affected by many external economic factors, including inflation. When inflation is concerningly high, mortgage rates rise to hedge against the increased risk and uncertainty taken on by banks when lending money in inflationary times.
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