Possible Rate Increase…..
The TSX was down about 280 points this morning, but surprisingly bond yields have not followed. In fact the 5 year bond is yielding 2.26 which is up from 1.94 just four weeks ago. What does this mean? Well, if bond yields continue to increase this will result in the banks making less money on the spread between their current low mortgage rates and the rate of the 5 year bonds. As we all know banks are not in business to make less money so they will increase their mortgage rates to keep profits up.
I explained in an earlier post how the bank’s make money on mortgages, but I will recap briefly. I stated the bank’s “spreads” are decreasing. Let’s assume your bank is currently lending money for mortgages at 3.80%. This would result in their “spread” (or profit) being 3.80-2.26=1.54%. The bank has two choices, they can lend you the money or they can invest the money in a 5 year bond and make 2.26%. If they lend you the money they need to be compensated for the extra risk of you defaulting on the mortgage, plus they need to cover the cost of administeringyour mortgage over the next 5 years. Finally they need to make a profit. So that 1.54% premium they charge over the 5 year bond rate covers all of those things. As you can see there is not much room there to begin with and if bond yields begin to increase resulting in a decrease of the premium, it doesn’t take long for the bank to start losing money on your mortgage.
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