BUSINESS

Canadian Mortgage Rates Head Up: RBC, BMO Lead The Pack In Raising Borrowing Costs

08/24/2011 09:00 EDT | Updated 10/24/2011 05:12 EDT
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TORONTO - Royal Bank of Canada (TSX:RY) is raising its variable rate mortgages for homebuyers in a move that reflects higher costs of borrowing in the bond market.

Canada's largest bank said Tuesday it is hiking the rates charged on its five-year variable closed mortgages by a fifth of a point, effective Wednesday.

That will put that rate even with the bank's prime rate of three per cent.

Bank of Montreal later joined Royal in raising its five-year variable closed mortgage to three per cent which, in the case of BMO, represented a 0.15 percentage point increase.

Meanwhile, the Royal's special variable rate mortgage also increased by a fifth of a point to prime minus 0.45 percentage points, making it 2.55 per cent.

In the past when banks raised variable rates without a corresponding increase in the Bank of Canada rate, they were accused of trying to boost profit margins at the expense of borrowers.

But Royal Bank, which is also Canada's largest mortgage lender, said the latest increase reflects higher costs in the bond market, where it raises money to finance its mortgage loans.

Bond interest rates have risen due to growing debt fears in the United States and Europe as lenders want higher rates to part with their money in a riskier global economy.

The increase in market interest rates comes at the same time central banks are keeping their rates low to stimulate the weak economy.

In the U.S., the Federal Reserve Board has said it will keep interest rates flat for another two years to spur growth, while the Bank of Canada is also expected to hold the line on rates well into next year.

Low mortgage rates in recent years have been a big factor in spurring growth in the Canadian housing market, which remains buoyant in most parts of the country.

Although it is unusual for banks to hike their variable rates without a rise in the Bank of Canada's overnight lending rate, it is not unprecedented.

"This is not the first time that the price for variable rate mortgages is changing relative to prime without a corresponding change in the BOC rate," a Royal Bank spokesman said in an email.

"In fact, over the period that BOC increased its overnight rate from 0.25 per cent to one per cent, the bank reduced the pricing levels for new mortgages relative to prime."

The mortgage market is highly competitive in Canada and in the past variable rate mortgages were popular with borrowers when interest rates were expected to remain low and there was little chance of sudden hikes in borrowing costs.

In the last few months, more consumers opted to lock into fixed terms when it looked like the Bank of Canada would begin to push rates sharply higher to fight inflationary pressures in the economy.

But the recent stock market and economic turmoil that has kept central bank rates low could push borrowers back to variable terms in the Canadian market.

Royal Bank said the Bank of Canada's rate is just one of many factors that go into pricing decisions. Banks mortgage costs are also based on changes in the bond markets, where rates have been volatile and banks raise money for their mortgage lending.

Recent global uncertainty over whether the U.S. can come up with a plan to deal with its debt problems, and over fears the debt crises in smaller European economies will spread across the continent, have caused bond rates to rise.

That makes it more expensive for banks to fund their mortgage operations, and led RBC to recoup some of those costs through a higher variable rate.

"Mortgage rates are tied to the banks funding costs which change from day to day," the bank said. "Due to global economic concerns, the funding costs for banks have been increasing.

"While we have held off in passing on these high costs to our clients, it is now necessary for us to increase this mortgage rate."

The big Canadian banks usually move in tandem when there is a variable rate change along with a change in the Bank of Canada's overnight lending rate, but its unclear whether the rest will follow this time.

Competitive pressures could force some banks to keep variable rates low to attract customers.

Royal Bank will report its third-quarter results on Friday.