The era of cheap debt and low inflation in Canada is now definitely behind us — and it’s gone very quickly. The 5-year Government of Canada (GC) bond closed at the highest level in a decade today. Five-year yields are important for real estate, influencing one of the main mortgage rates. As a result, Canadians should expect to pay the highest mortgage interest rates in a decade — and those rates are just getting started.
Bond yields influence mortgage rates
Government bond yields influence the cost of interest on debt of similar terms. When yields rise or fall, the cost of interest on debt is only a few steps behind. One of the most important bonds is the 5 year, directly influencing the 5 year fixed rate mortgage. The mortgage also happens to be one of the most popular mortgage products. Especially when interest rates rise.
Canadian bond yields hit their highest level in a decade
The yield on 5-year government bonds is climbing at a generally rapid pace these days. The yield closed the week at 2.544% today, up 7.65 basis points (bps) from last week. Over the past month, the yield has climbed 74.25 basis points, one of the fastest jumps ever. Canada had not experienced such a summit since April 2011, more than ten years ago.
Government of Canada 5-Year Bond Yield
The percentage yield of the 5-year Government of Canada bond.
Source: Bank of Canada; Live better.
We don’t need to go far back to show how oddly fast the climb was. Yield rose 158.67 basis points from a year ago, meaning last month accounted for almost half of the increase. To say this is a rapid pace would be to underestimate this crisis-like movement in response to inflation.
Canadian 5-year fixed rate mortgages soar
Canada has also seen 5-year fixed mortgage rates climb just as quickly. For example, RBC’s posted rate was near a record low of 2.19% as recently as October. To date, it has risen to 3.94%, a significant increase in such a short time. In situations where a stress test is not applied, a buyer would see a 17% drop in their maximum buying power. Stress-tested buyers are already being tested at a higher interest rate of 5.25%, so their maximum mortgage is only minimally affected. Although this rate cycle is the first time a buyer’s contract rate plus 2 points can breach the current stress test threshold, which means the first drop in leverage in years.
Five-year fixed-term mortgages were the most popular mortgages until recently. When these started to climb a year ago, buyers began to consider variable rate mortgages. These are based on the overnight rate, which has not followed market expectations. This left a vacuum of cheap money that buyers were more than ready to take advantage of. With the overnight rate climbing with 5-year fixed rates, there is nothing left to hide. As a result, some economists expect a revaluation of assets – a fancy way of saying a drop in house prices.