Rising Bond Yields Threaten Canadian Housing Affordability
Canadian homebuyers face mounting pressure as government bond yields surge across developed markets, setting the stage for significantly higher mortgage rates and reduced borrowing capacity in 2026.
Global Bond Market Turbulence Spreads to Canada
The yield on Canada's 5-year government bond has climbed from 2.5% to 2.9% since early April 2025, already exceeding major Canadian banks' forecasts of 2.4% to 2.8% by the end of June. This surge mirrors a global trend that has seen 30-year bond yields reach multi-decade highs across developed economies, driven by fiscal concerns and structural changes in bond markets.
The global bond selloff stems from multiple factors. America's $2 trillion annual deficit (6.9% of GDP) and President Trump's recently passed budget bill have shaken confidence in government debt sustainability.
Meanwhile, institutional buyers like pension funds, traditionally major purchasers of long-term government bonds, have reduced their market participation after locking in attractive yields over recent years. With many baby boomers beginning to draw on their pension savings, the impact of pensions lower participation in bond markets may be prolonged.
Direct Impact on Canadian Mortgage Markets
Canadian 5-year fixed mortgage rates are intrinsically linked to 5-year government bond yields, as lenders use these bonds as their pricing benchmark. Banks typically add a spread of 1% to 3% above government bond yields to account for credit risk, operational costs, and profit margins.
With government bond yields rising faster than expected, Canadian mortgage rates are poised to climb substantially. Current low 5-year fixed rates of approximately 4% could easily reach 5% or higher by 2026 if bond market pressures persist.
Dramatic Reduction in Borrowing Capacity
The relationship between mortgage rates and borrowing capacity follows a steep curve that significantly impacts homebuyer purchasing power. Based on standard lending criteria that limit mortgage payments to 39% of gross income, a borrower's qualification amount varies dramatically with rate changes:
At 4% mortgage rates: 5.04 times annual income
At 5% mortgage rates: 4.60 times annual income
At 6% mortgage rates: 4.21 times annual income
This means a household earning $100,000 annually could qualify for a $504,000 mortgage at 4% rates, but only $460,000 at 5% rates, a reduction of $44,000 in borrowing capacity from just a single percentage point increase.
Market Outlook and Risks
The convergence of fiscal pressures, inflation concerns, and structural changes in bond markets suggests higher yields may persist longer than previously anticipated. Goldman Sachs analysts note that traditional institutional demand for government bonds is drying up precisely when supply remains elevated due to large fiscal deficits and central bank balance sheet reductions.
For Canadian homebuyers, this creates a challenging environment where affordability continues to erode. If bond yields maintain their upward trajectory and lender risk spreads widen due to economic uncertainty, mortgage rates could climb even more aggressively than government bond yields alone would suggest.
The implications extend beyond individual borrowers to the broader Canadian housing market, where reduced affordability typically translates to slower price growth or potential price corrections, depending on supply dynamics and regional factors.
