Glossary
Term Premium
The extra yield investors demand for lending money over a longer period instead of rolling over short-term investments, reflecting added uncertainty..
A term premium is the extra yield investors demand for committing money over a longer period instead of repeatedly reinvesting at short-term rates. It compensates the lender for the added uncertainty that comes with a longer horizon — about inflation, future interest rates, and the risk of being locked into a below-market return.
How the term premium reaches Canadian mortgages
Canadian lenders do not fund fixed-rate mortgages purely from deposits. They rely heavily on wholesale funding, and fixed mortgage pricing is generally referenced to Government of Canada bonds whose term matches the mortgage term. The yield on those bonds is commonly described as three pieces: the expected path of short-term rates, a credit spread for the borrower's risk, and the term premium.
That matters because the term premium can move independently of the policy interest rate. The Bank of Canada sets the overnight rate, which anchors short-term borrowing and feeds into prime rate. Long bond yields, however, also reflect investor demand for long-dated government debt, inflation expectations, and how much compensation investors want for holding it. When the term premium widens, longer bond yields rise even with no change to the policy rate, and fixed mortgage rates typically follow. The same dynamic shapes the yield curve: a curve that steepens at the long end often signals a larger term premium.
Why it matters to a borrower
- Fixed-rate borrowers feel it at renewal or on a new mortgage, because it is built into the bond yield the lender prices from.
- Variable-rate borrowers are affected mainly by the policy rate and prime rate, so the term premium matters less to them.
- Term length matters: a longer lock-in generally carries more term premium than a shorter one, which is why longer fixed terms are not always cheaper.
- Timing matters: a bond market move driven by term premium can shift fixed rates before any central bank announcement.
As a rough comparison, imagine two borrowers choosing between a short fixed term and a longer fixed term on the same day. If investors are demanding more compensation to hold long-dated bonds, the longer term will carry a wider premium, and the gap between the two rates narrows or reverses — even though both borrowers have identical credit profiles. Neither outcome is guaranteed, and pricing changes daily.
The practical takeaway is that fixed mortgage rates are not set by the Bank of Canada alone. Reading the guide to how mortgage rates work in Canada helps borrowers understand which forces affect which product.
Frequently asked questions
What causes the term premium to change?
It shifts with investor demand for long-dated government bonds, inflation uncertainty, expectations about future central bank policy, and the volume of government debt being issued. Because it reflects sentiment and risk appetite rather than a set formula, it can widen or narrow without any change to the Bank of Canada's policy rate.
Does the term premium affect my existing fixed mortgage?
No. Once a fixed rate is locked in for the term, your payment does not change with bond market moves. The term premium only matters to you at renewal, when refinancing, or when you break the mortgage, since it feeds into the rate your lender offers at that point.
Why do fixed mortgage rates follow bond yields?
Lenders fund fixed-rate mortgages largely through wholesale borrowing rather than deposits alone, and Government of Canada bonds of a similar term are the usual reference point. The bond yield includes a term premium, so when that premium moves, the cost of funding moves and fixed mortgage rates tend to follow.
Sources
Related terms
- Yield Curve — The relationship between bond yields and time to maturity, which shapes how Canadian lenders price fixed-rate mortgages.
- Credit Spread — A credit spread is the difference in yield between two debt instruments of different credit quality, reflecting how much extra return lenders demand for added risk.
- Benchmark Rate — A published reference rate — such as the Bank of Canada's policy rate or prime rate — that other interest rates are quoted against.
- Fixed-Rate Mortgage — A fixed-rate mortgage keeps the same interest rate and the same scheduled payment for the entire mortgage term, so each payment is known in advance.
- Mortgage Term — A mortgage term is the length of your current contract with a lender, during which your rate and conditions stay in force — always shorter than the amortization period.