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Homework: On Thursday the Bank of Montreal (BMO) announced that it was reducing the annual interest...

Homework:

On Thursday the Bank of Montreal (BMO) announced that it was reducing the annual interest rate on their 5-year fixed-rate mortgage to 2.99%, the lowest in the bank’s history. Shortly after the BMO’s announcement, TD-Canada Trust issued a news-release to inform the markets that they, too, would be offering that low interest rate, followed shortly after with the same offer coming from the Royal Bank (RBC), Scotiabank and the CIBC.

Those low interest rates were being offered at a time when many financial experts, including the governor of the Bank of Canada, and the federal Minister of Finance had been warning all Canadians about the dangers of borrowing money, especially money that is being offered at very low interest rates.

Here we are, again, a bit more than one year later, and history is repeating itself, with the BMO and Manulife Insurance offering the cheapest rates on the street. This is not surprising, because March is usually the beginning of the “spring home-buying season” when people begin to look at buying either their first home or are considering “trading up” to a better home.

Question:

Why are banks, and other lenders, able to provide consumers with offers such these low-rate loans in today’s market?

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Answer #1

We live in an era of cheap credit. The interest rates globally have never been cheaper, in fact they are negative in some countries which is unprecedented in economic history.

The rates at which a bank lends money is dependent directly on the benchmark interest rates in the economy at which the central bank lends money to the banks. Lower the benchmark interest rates in an economy, lower will be the rates at which banks lend money to consumers.

While the benchmark interest rates have lowered gradually since the last two decades, the post 2008 recession era has seen benchmark interest rates take a severe beating because of push by Central banks around the world to stimulate the economic growth in their respective economies.

When the cost of funds for banks go down, they push that cost benefit to their consumers to gain larger market shares and hence they provide consumers with lucrative interest rates.

Canada's long-term benchmark interest rates (Links or references to outside sources are not allowed)

Canada's long-term interest rates were close to 4% in 2007 and they are less than 2% today. This shows the cost of funds for Canadian banks has gone down dramatically which has then resulted in them providing cheaper loans to their customers to increase lending and gain larger market shares.

Therefore, the radical fall in benchmark long-term interest rates in Canada is the reason that Bank of Montreal, RBC, CIBC, etc are able to provide their customers with such low-rate loans these days.

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