Bond yields and mortgage rates share an intricate relationship that directly affects Canadian homebuyers and property investors. Bond yields in Canada have fluctuated considerably over the past year, with highs of nearly 4% and lows around 2.8%. As of May 14, 2025, the Canada 5-year bond yield stands at 2.8%, while fixed mortgage rates currently range from 4.5% to 5.2% for 5-year terms. This spread of about 140-210 basis points between bond yields and mortgage rates illustrates the pricing mechanism lenders use when determining their fixed-rate offerings.
By tracking the movement of bond yields, you can anticipate potential changes in mortgage rates before they occur and make better decisions about when to secure a mortgage. Read on to gain insights on how bond yields affect mortgage rates in Canada.
How Does The Canadian Bond Market Work?
Government bonds are debt securities issued by the Government of Canada to finance public spending. When you buy a government bond, you’re essentially lending money to the government for a specific period, after which they repay you the principal amount plus interest.
Bonds are primarily issued to financial institutions, which then sell them as investment products to clients. These bonds can be held until maturity to collect interest or traded on the secondary market, where their prices fluctuate based on market conditions. Government bonds are considered extremely low-risk investments because they’re backed by the federal government.
What Is a Bond Yield?
Bond yields represent the return an investor receives on a bond investment, expressed as a percentage. The yield calculation takes into account the bond’s purchase price, face value, coupon rate (fixed interest payment), and time to maturity. As bond prices fluctuate in the market, their yields change inversely:
- When bond prices rise, yields fall
- When bond prices fall, yields rise
For example, if a 5-year Government of Canada bond with a face value of $700 offers an annual interest payment of $50, its initial yield would be 7.1% ($50 ÷ $700). If demand for this bond increases and its market price rises to $800, the yield would decrease to approximately 6.25% ($50 ÷ $900).
What Causes Government Bond Yields To Change?
Government bond yields fluctuate based on three main factors
Bank Of Canada Decisions
The Bank of Canada’s actions significantly impact bond yields. When the central bank raises its policy interest rate, bond yields usually rise in response. This relationship makes sense because the policy rate influences short-term interest rates throughout the economy.
Inflation
Inflation erodes the purchasing power of fixed interest payments. When inflation expectations rise, investors demand higher yields to compensate for this loss of purchasing power, pushing bond yields upward and consequently driving fixed mortgage rates higher.
For example, as Canadian inflation surged above 8% in 2022, bond yields rose dramatically as investors sought protection against diminishing returns.
Economic Conditions
Central banks are anticipated to raise interest rates when the economy grows strongly, leading to higher bond yields. It also increases demand for credit, driving up interest rates across financial markets. Canadian bond yields are also affected by international economic developments, including interest rates in other countries (particularly the United States) and global geopolitical events.
Why Do Banks Use Bond Yields To Set Mortgage Rates?
Banks use bond yields as a benchmark for setting mortgage rates because bonds represent their cost of funds and provide a nearly guaranteed minimum return on investment. For banks, offering mortgages must be more profitable than simply investing in government bonds to justify the additional risk.
When a bank issues a 5-year fixed-rate mortgage, it needs to ensure it can fund that mortgage for the entire term. Government bonds provide a reliable way to match this funding requirement.
Why Are Mortgage Rates Higher Than Bond Yields?
Mortgage rates are set higher than bond yields, typically 1-2 percentage points above, to compensate lenders for the additional risk and costs associated with mortgage lending. This spread covers 5 important factors:
- Credit risk: Unlike government bonds, mortgages carry the risk of default. Lenders add a premium to cover potential losses from borrowers who fail to make payments.
- Operational costs: Mortgages require significant administrative resources to originate, service, and monitor, including staff, systems, and regulatory compliance costs.
- Liquidity premium: Government bonds can be easily bought and sold in large, liquid markets. Mortgages are less liquid, and lenders add a premium to compensate for this reduced flexibility.
- Profit margin: Lenders need to generate returns for their shareholders or investors.
- Prepayment risk: Borrowers may pay off mortgages early when rates fall, forcing lenders to reinvest at lower rates.
A common misconception is that the Bank of Canada overnight rate determines all mortgage rates. While this is true for variable-rate mortgages, fixed-rate mortgages are more closely tied to bond market movements.
How Do Bond Yields Affect Different Types Of Mortgage Rates?
Bond yields have a direct impact on fixed-rate mortgages but a much more limited influence on variable-rate mortgages, with each type of mortgage responding to different economic indicators.
Bong Yields Impacts on Fixed-Rate Mortgages
Bond yields directly affect fixed-rate mortgages because lenders use them to determine these rates. Specifically, the 5-year Government of Canada bond yield strongly correlates with 5-year fixed mortgage rates, among Canada’s most popular mortgage products.
Canadian lenders follow a systematic process when setting fixed mortgage rates:
- They monitor the corresponding government bond yield (e.g., 5-year bond yield for 5-year mortgages)
- Add a spread of typically 1-2 percentage points to cover risk, operational costs, and profit
- Adjust this spread based on competitive pressures and market conditions
- Set their posted and special offer rates accordingly
This close relationship means that watching bond yield trends can give you advance notice of potential changes in fixed mortgage rates. If you see bond yields rising steadily over several days, it indicates that fixed mortgage rates will soon increase.
Do Bond Yields Affect Variable Mortgage Rates?
Variable mortgage rates are primarily influenced by the Bank of Canada’s policy interest rate rather than bond yields. However, bond yields can indirectly affect variable rates by influencing market expectations about future central bank decisions.
The Bank of Canada sets the overnight lending rate, which directly impacts the prime rate that lenders use as the basis for variable mortgage rates. Variable-rate mortgages are typically expressed as prime plus or minus a certain percentage (e.g., prime – 0.15%).
Bond yields can serve as predictive indicators of future Bank of Canada rate movements. When long-term bond yields rise significantly, it may signal that the market expects the central bank to raise rates in the future, which could eventually affect variable mortgage rates.
Understanding bond yield trends can be valuable for borrowers trying to choose between fixed and variable rates. If bond yields are rising rapidly, it might indicate that fixed rates will continue to increase, potentially making current fixed rates more attractive. Conversely, if yields are stable or falling, variable rates might offer better value.
Do All Canadian Lenders Use The Same Yield Spread?
Different Canadian lenders apply varying spreads above bond yields when setting their mortgage rates, creating opportunities for borrowers to shop around for better deals. This variation occurs because lenders have different:
- Funding costs: Some lenders, particularly large banks with diverse funding sources, may have lower costs than smaller monoline lenders.
- Risk appetites: Lenders with more conservative lending policies might charge higher rates to offset perceived risks.
- Operational efficiency: More efficient lenders can operate with smaller spreads while maintaining profitability.
- Competitive positioning: Some lenders may choose to maintain tighter spreads to gain market share or target specific customer segments.
To identify competitive mortgage offers, compare the spread between current bond yields and offered mortgage rates across multiple lenders. For example, if the 5-year bond yield is 2.35% and Lender A offers a 5-year fixed rate of 3.75% while Lender B offers 4.15%, Lender A’s spread is 140 basis points versus Lender B’s 180 basis points.
Mortgage brokers often have access to multiple lenders and can help identify which ones are offering the most competitive spreads at any given time.
How to Monitor Bond Yields for Mortgage Planning?
Tracking bond yields can give you valuable insights when planning your mortgage strategy:
- Watch the 5-year Government of Canada bond yield: This is the benchmark most closely correlated with 5-year fixed mortgage rates. You can find this information on financial news sites or the Bank of Canada website.
- Look for sustained trends: Focus on consistent movements over days or weeks rather than daily fluctuations, as lenders typically adjust their rates in response to sustained trends.
- Compare current yields to historical context: Understanding where current yields sit relative to recent highs and lows provides perspective on whether rates are likely near their peak or floor.
- Consider the spread between bond yields and mortgage rates: If the spread is wider than the typical 1-2%, this might indicate lenders are being cautious or that rates have room to fall even if bond yields remain stable.
FAQs on How Bond Yields Affect Mortgage Rates
Can bond yields predict Bank of Canada rate decisions?
Bond yields, particularly short-term yields, often reflect market expectations about future Bank of Canada decisions. When short-term bond yields rise significantly, it typically indicates that the market anticipates rate hikes. Similarly, falling yields suggest expectations of rate cuts. While not perfect predictors, sudden large movements in bond yields before scheduled Bank of Canada announcements often signal that the market is pricing in a policy change.
How quickly do lenders respond to falling bond yields versus rising yields?
Lenders typically respond more quickly to rising bond yields than to falling yields. When yields increase, lenders often raise their fixed mortgage rates within days to protect their margins. However, when bond yields fall, lenders may delay lowering their rates for weeks, capitalizing on the wider spread to increase profitability.
Is there a seasonal pattern to bond yield movements that affects mortgage rates?
While bond yields don't follow strict seasonal patterns, certain calendar-related factors can influence them. Government fiscal year-ends and new budget announcements often affect bond issuance, potentially impacting yields.
What is the negative correlation between bond yields and mortgage rates?
Negative correlation between bond yields and mortgage rates doesn't actually exist in normal markets; they typically move in the same direction. However, during extreme market stress or liquidity crises, this relationship can temporarily decouple.
The Bottom Line
This article has discussed how bond yields influence fixed mortgage rates, which can help you decide when to secure financing and which mortgage products best suit your needs. Consult a mortgage advisor at Best Mortgage Online for the most current information on bond yields and personalized mortgage advice.
Article Sources
At Best Mortgage Online, we cite statistics from trusted governmental and industry organizations to guarantee accuracy.
