Canadian Mortgage Rates Set To Rise As Lender Margins Collapse

Government of Canada bond yields made an abrupt surge yesterday, extending a trend that kicked off in February. Despite the aggressive rise, mortgage rates haven’t climbed with them as expected. A Big Six bank says lenders are absorbing the shock and it’s not sustainable. They’re warning investors that mortgage rates will begin to climb soon, worsening affordability for the first time in 3 years. 

Canadian Bond Yields and Mortgage Costs 

The real estate industry pays a lot of attention to the Bank of Canada’s (BoC) overnight rate, but that only impacts variable rate mortgages, a minority of the market. The vast majority of borrowers use fixed terms, which are determined by bond yields of similar terms. The most important example when it comes to Canadian fixed rate mortgages is the 5-year bond yield, which determines the interest paid on a 5-year fixed rate mortgage. 

Credit is a market where all borrowers compete for capital, where the highest quality borrowers are the cheapest as they present the least relative risk. In this case, it’s the currency issuer—the Government of Canada (GoC), whose bonds set the base cost of borrowing, known as the benchmark yield. All other issuers of similar terms compete for investor capital by adding premiums for risk, liquidity, and profit. This premium is known as a spread, and that’s a point we’ll circle back to in a moment. 

Canadian Bond Yields Have Surged 92 Basis Points

Bond yields across the world have seen a sharp uptick, and Canada was no exception. The GoC 5-year bond yield jumped 16 basis points (bps) to 3.65% yesterday, hitting its highest level since May 2024. It’s climbed a whopping 92 bps since February’s cycle lows, equivalent to almost 4 rate hikes for variable rate mortgages. 

As mentioned, Canada isn’t alone in this regard—it actually experienced less pressure than our neighbors to the south. The U.S. saw its equivalent, the 5-year Treasury yield, jump 15 bps to 4.76% yesterday, adding 118 bps since February. The fallout from the Iran War and the resulting surge in energy prices is a contributing factor, but it’s a wider issue according to at least one Canadian bank. 

“The spike observed today, however, is not an isolated event but is part of an upward trend that began after the low in February, before the conflict in Iran began,” warned National Bank senior economists Daren King & Kyle Dahms.

In a report to investors this morning, they explain the geopolitical shock accelerated the trend—it didn’t create it. Regardless of the input factors, households are likely to face higher mortgage bills.  

Canadian Mortgage Lenders Have Been Absorbing Higher Yields

The bank’s analysis shows mortgages have yet to reflect rising bond yields. Despite Canada’s 5-year bond yield rising 92 bps since February, mortgages only reflect 40 bps of the increase. “The impact on Canadian mortgage borrowers has remained more contained so far,” explains the bank.  

Source: National Bank.

The 52 bp gap has been absorbed by narrowing spreads, the bank said. Their calculations show the spread averaged 135 bps since late 2023, but currently sits at just 75 bps. That’s roughly 60 bps that lenders are absorbing in the spread, typically an attempt to bolster credit demand. However, it’s a temporary solution, and not easy to maintain over the long run. 

“Such a narrow spread puts pressure on lenders’ margins and is likely unsustainable in the long run,” say the economists. The bank expects this will begin to have an impact on affordability, defined as payments as a share of household income. 

National Bank Warns Affordability Will Erode, Mortgages To Rise

National Bank expects mortgage rates will rise in the coming weeks as lenders rebuild margins. Rising payments are seen ending the 11 quarter streak of affordability improvements in Q3 2026. By Q4, they see affordability eroding 1.1 percentage points. “Mortgage rates are therefore likely to rise in the coming weeks… marking the first deterioration in affordability in three years,” warns the bank. 

There’s been a sharp improvement in affordability since 2023, when rate hikes started in 2022 began to reverse. The improvements were driven by falling home prices, cheaper financing, and rising real household income. However, home prices are stalling, financing costs are rising, and incomes are now stalling. 

While Canadian banks have made similar observations, they don’t all agree on the outcome. A few weeks ago, RBC called a bottom for the market, noting that home prices are starting to move higher. It was their 8th attempt at calling the bottom of the market in 4 years though, and appears to lack consideration of factors like financing and incomes. A more logical take came from BMO earlier this week. 

BMO economists noted the same factors of home prices, rising rates, and real incomes. The bank’s economists also don’t see the upward pressure on borrowing costs fading anytime soon, and warn that trade uncertainty will apply downward pressure on income growth rates. However, they warned investors that they remain bearish on home prices under these conditions, as they have no other direction to move. 

BMO’s take doesn’t necessarily conflict with National Bank. They can both be right if the cost of financing rises faster than home prices fall. It’s a combination that would imply market inefficiency, with a bigger drag on the economy. Though policymakers aren’t exactly known for embracing market efficiency, even if the inefficient market impacts home sales and puts a drag on overall economic growth.