# Interest rate by qingyunliuliu

VIEWS: 24 PAGES: 2

• pg 1
```									Article taken from the website: http://www.informezvous.com

Who decides when interest rates rise or fall?

by Gregory van Duyse

To choose the right mortgage strategy and save lots of money, you must first understand
the circumstances that push banks and mortgage lenders to raise or lower interest rates.

Fiscal policy and the bond market are both subjects that could fill several books, so we’ll
approach the subject simply.

We have the impression that it is banks who decide to raise or lower interest rates for the
mortgage market and in a sense this is true. They make the final decision to react to other
factors.

First, let’s separate the subject of interest rates into two parts:

1. The variable rate mortgage, which is controlled by the prime rate.
2. The fixed rate or long-term rates of various mortgage lenders.

The prime rate and the Bank of Canada

The base rate is controlled by the Bank of Canada, and it has a direct impact on the prime
rate of all the major Canadian banks.

How does a variable rate mortgage work?

Many people let themselves be influenced by variable rates: “Wow, I got a rate of 4.75%
for 5 years!” (when the 5-year fixed rate is 5.25%). What you must understand is that
variable rates rise and fall with the prime rate. If the prime rate is 5.50% and the client has
a rate of 4.75%, then it is more precise to say that he received a variable rate of “the prime
rate minus 0.75%.” When the prime rate goes up by a quarter of a point (to 5.75%, for
example), his mortgage rate will be 5.00% over this period (+/- 6 weeks).

The prime rate is established eight times per year at precise intervals. It’s at this moment
that David Dodge, Governor of the Bank of Canada, decides to raise, lower, or stabilize the
base rate and the prime rate until the next meeting.

The following factors seem to influence the prime rate:

1. Changes in the consumer price index of Canada (inflation). When the inflation rate is
more than 2% per year, interest rates have a tendency to increase.
2. Changes in the Canadian economy (GDP).

In general, when the economy is weak and inflation is under control (1% to 3% annually),
the Bank of Canada tends to reduce interest rates to stimulate the economy.

The inverse tendency also exists. When the economy is strong (which often drives the
inflation rate upward), the Bank of Canada raises interest rates to calm the economy and
the consumer.
Here is a graph of the prime rates over the past 10 years.

[Figure heading: Prime rates of large Canadian chartered banks from 1996 to 2006; x-axis
label: Month and year}

The fixed or long-term rate

Each lender establishes its own fixed rate.

To understand why interest rates are increased and decreased, it is important to remember
that banks periodically sell their mortgage portfolios on a secondary market.

Now when an investor who buys a portfolio of mortgages on the secondary market sees the
interest rates increase on the bond market, he expects to get a higher rate for his mortgage
portfolio. If the investor expects a higher rate, then the bank or mortgage lender has no
choice but to increase the interest rates that they offer their clients. The opposite (when
rates go down) is also true.

In conclusion, whether for variable rates or for longer-term fixed rates, the interest rate of
your mortgage will rise and fall largely according to the fiscal policy of the Bank of Canada.
When Mr. David Dodge decides to raise the rate, it is often only a question of time before
the bond market follows (and even sometimes anticipates) this trend and mortgage lenders
react by raising their fixed rates.