Mortgage rates rise as bonds grow

TORONTO -- Improved investor confidence and increased government spending may be good for the overall economy, but it can be bad news for home buyers as bond yields rise and push up fixed mortgage rates.

All of Canada's big banks increased the interest rates for their five-year, fixed-rate mortgages by 0.2 percentage points to 5.45% last week.

These increases came as investors pushed up rates on government bonds that influence the the cost of mortgages.

Eric Lascelles, chief economist and rates strategist at TD Securities, said a number of economic factors have played a role in doubling Canadian government bond yields from a low of 1.25% in late 2008 to about 2.5%.

Government bond yields are inversely related to demand: as the economy soured late last year, investors flocked to the safe haven of government debt, pushing yields down. Now, as the economy begins to show signs of improvement, demand for government bonds is shrinking, pushing yields up -- and fixed mortgage rates along with them.

Lascelles added that governments around the world are issuing more and more bonds as they increase borrowing to support massive stimulus projects.

"There's the concern that at some point demand just isn't going to keep up with supply, and you're going to have so many bonds out there and nobody's going to want them," he said.

"If that happens . . . you've basically got to pay a higher return to lure people in to buy those government bonds."

Lascelles described the doubling of bond rates in roughly six months as an "astonishingly concerted push" and said no one should be surprised that fixed mortgage rates are rising, too.

"Historically there has been a pretty good link between government yields and mortgage rates," he said. "A 1.25 (percentage point) increase in the level of government yields suggests an inevitability to mortgage rates going up a little bit, and that's what we've seen."

There are two broad categories of mortgages: fixed-rate mortgages have locked-in rates for the length of their term and are linked to bond market yields, while variable-rate mortgages shift along with the Bank of Canada's overnight lending rate, which was left at its lowest-ever rate of 0.25% on Thursday.

Jim Murphy, president and chief executive of the Canadian Association of Accredited Mortgage Professionals, said mortgage rates have been at historical lows for two months and it isn't surprising to see fixed rates creeping upwards, but consumers shouldn't worry that rates will skyrocket.

"I don't think anybody's predicting that we'll go back to where we were in the early 1980s with double-digit rates in the high teens," he said. "But rates have been very low and as the economy improves and hopefully employment and other situations improve, you're likely to see increases in rates."

While variable-rate mortgages are much cheaper than fixed-rate ones right now -- the Bank of Montreal is offering five-year, variable-rate mortgages for 3.05% compared to 5.45% for a five-year, fixed-rate mortgage -- Murphy said consumers need to assess their risk aversion before they decide which to buy.

"Historically, research shows that you're always better with a variable rate, but most Canadians take fixed rates and the vast majority of those take five-year," he said. "Really, it's a question of your own financial situation and your own peace of mind."  

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