The 2022 federal budget made way for a new tax-free savings account (TFSA) designed specifically for first-time home buyers in Canada. The account ultimately combines the advantages of the existing TFSA and registered retirement savings plan (RRSP) – popular down…
The prime rate in Canada is a floating figure calculated using the Bank of Canada overnight target rate that applies to variable mortgage products. Additionally, as the BOC’s overnight target rate continues to change annually, it also affects the prime interest rate, which is used as a benchmark for various mortgage transactions in Canada. Because prime rates change along with the overnight target rate, some refer to it as the bank of Canada prime rate. But in the real sense, the lender sets the prime and not the Bank of Canada.
The Canadian prime rate today is set at 2.70%, slightly higher than it was at the start of 2020 after falling from its previous level of 3.95%. It comes after the accelerated cuts to the overnight rate to help boost the economy hit by the COVID 19 pandemic and minimize the financial impact on the population.
However, there is a high probability of rates rising in the near future. Trends from the US market indicate rapidly rising rates with the federal government having just raised the rates. Freddie Mac quotes as of 10th March see 30-year fixed rates up to 3.85% after rising by 9 basis points and 15-year fixed rates up to 3.09% after rising by 8 basis points. The Canadian market would see a similar effect and in the long term. The ongoing and unfortunate conflict in Ukraine and rising inflation rates are also contributing to rate volatility.
Key Takeaways
- Prime rate is the base that depository banks use as a starting point for their variable interest rates products such as variable mortgages, HELOC, variable rate car loans, and APR credit cards
- Overnight rates, prime rates, and bank rates are different in the sense that bank rates affect banks borrowing from the BOC. Overnight rates affect the bank’s prime rate and the rate at which depository commercial banks lend to themselves
- The prime rate in Canada has recorded significant changes over the last 87 years from its introduction in 1935 to date. It recorded its all-time high of 20.03% in August 1981
Prime Rate vs Bank of Canada Overnight Rate (1935 – 2022)
As mentioned before, the prime rate in Canada refers to the base interest rate set by the banks in using the BOC rates as their starting point for varying their mortgage interest rates. On the other hand, overnight rates are determined by the BOC, and it affects the changes in prime rates.
Talking about the prime rate in Canada, history has recorded significant changes over the last 87 years. With an all-time high of 20.03% in August 1981 when the bank of Canada hiked rates to control inflation to the lowest rate of 2.25% in April 2009 during the financial crises, Canadian borrowers have seen several changes in their mortgage journey. The longest period that the prime mortgage rate remained unchanged at 3.0% was between September 2010 to January 2015.
Since the introduction of inflation targeting in 1991, the most significant increase in prime interest rate in Canada was 4.25%. From its rate of 2.5% in 1935, the current prime rate as of February 2022 still stands at 2.45%, only 0.5% less than its previous value of 2.5%, as seen in March 2020.
Types of Loans Impacted by the Prime Rate
Variable-rate mortgage
A variable-rate mortgage is one that fluctuates with the prime CA rates throughout the period of the mortgage term. Based on the current market conditions, your variable-rate mortgage interest will increase or decrease depending on what the bank prime rate is, which also impacts your monthly principal payments. If you choose a variable mortgage rate home loan, you may be able to take advantage of a decrease in CIBC prime rate if it does happen within your loan period. This means you’ll get to pay less interest on the home loan than what it would be if it was a fixed-rate mortgage loan.
Variable-rate car loans
Variable-rate car loans are those with interest rates that rise and fall with the royal bank prime rate. Your lender will add a little extra percentage on the base bank of Canada prime rate to acquire some profit as you make your monthly payment. Therefore, a variable rate car loan simply means having a variable interest rate where your repayments fluctuate with the market prime.
While variable-rate car loans could lead to lower interest rates due to the eventual fall of the prime rate in Canada, it could also pose a potential risk of interest skyrocketing if the prime lending rate in Canada rises in periods of financial prosperity.
Home equity lines of credit (HELOCs)
A home equity line of credit, also known as HELOC, refers to lines of credit secured using your home’s equity. HELOC is a way homeowners can access funds for renovations, large expenses, or an alternative debt repayment because it comes as a lump sum cash. Usually, lenders offering HELOC are willing to provide lesser interest rates than what is obtainable in personal loans.
Credit cards with variable APRs
Variable APR cards are credit cards with interest rates that change over time based on the prime interest rate in Canada. The rise and fall of the prime rate in Canada in line with the overnight target rates affect your card’s annual percentage rate (APR), causing you to pay more or less depending on the current prime rate.
Frequently Asked Questions: Prime Rate
What does Prime Rate mean?
The prime rate is the benchmark used by financial institutions to price variable-rate mortgages and other financial products in Canada. Financial products that rely on the prime interest rate in Canada include variable mortgages rates, variable-rate loans, variable-rate credit cards, lines of credit, and HELOC.
Who Sets the Prime Rate?
Each financial lender or bank in Canada can set its own prime rate, which must be based upon the current prime rate in Canada as stated by the Bank of Canada’s (BOC) overnight rate. Usually, changes to the target overnight rate affect the prime set by each lender. That means the RBC prime or Scotia prime rate may be different from HSBC prime, CIBC prime, BMO prime rate, or TD bank prime rate.
Whenever the BOC raises or decreases the overnight rate, it becomes more or less expensive for banks to borrow money from them, which in turn affects the prime rates for individual borrowers. As previously stated, banks will usually add an extra cost on the Bank of Canada prime rate to cover the changes and make some profit.
How does the Prime Rate impact my existing mortgage?
Prime is the minimum rate your mortgage lender will charge if you take out a home loan. Because bank prime rates are priced in line with BOC prime rates, you’ll most likely be paying a marked-up version of the current overnight rate. The higher the BOC prime rate, the higher the rate your lender will charge and vice versa.
Therefore, when your bank’s prime rate increases or decreases, your mortgage goes up and down in the same amount. As opposed to fixed-rate mortgages, variable-rate mortgages are affected by prime rate changes and usually come with lower interest rates due to the accompanying risk you incur during your mortgage term.
How does the Prime Rate impact my future mortgage?
As previously stated, the prime rate at any point in your mortgage term determines the interest you’ll pay as you go. If you look at the historical mortgage rates in Canada, you find that prime rates change from time to time, and borrowers have to deal with the changes that accompany a variable-rate mortgage.
Because the prime rate in Canada is influenced by the economy, your future mortgage interests will be affected by the economy and prime rate at that time. So when your borrow a home loan, be sure to consider the risk and rewards of the variable prime interest rate in Canada.
Frequently Asked Questions: Bank of Canada Target Overnight Rate
What is the Bank of Canada Target Overnight Rate?
The Bank of Canada expects the economy to grow by 4% in 2022 and has decided to keep its overnight target at 0.25%. In line with its forecast, a 3.5% target rate is also expected in 2023. Holding the BOC overnight rate at 0.25% removes any exceptional guidance, and the government plans to continue the reinvestment phase by maintaining its holdings.
Understanding the prime and overnight rates begins at the Bank of Canada decides the rates at any point in time. A lower prime rate usually means the Bank of Canada target overnight rates have been lowered. It also means your interest rate can take a hit if there’s a sudden increase in the prime rates of Canada.
Why Does the Prime Rate Follow the Bank of Canada Target Overnight Rate?
The overnight rate is the interest rate at which financial lenders can peg their prime rates and borrow funds from customers. When the bank of Canada’s overnight target rate increases, it becomes more expensive for lenders to borrow, which in turn affects their prime. Also, if the Bank of Canada lowers its overnight target rate, loan borrowers will also experience a decrease in interest rates.
Although the banks set their individual prime rate to match the BOC rate, the BOC cannot force financial institutions operating under their jurisdiction to charge a certain rate.
What is the relationship between the bank rate and the overnight rate?
The discounted rate or bank rate should not be mistaken with the overnight rate because the bank rate is the rate at which the Bank of Canada charges banks who want to borrow funds from it. On the other hand, the overnight rate is the BOC’s proposed rate at which depository banks can use to determine their prime rate for borrowing funds from customers. The overnight rate is also the interest rate at which banks can borrow funds from fellow depository banks in Canada. So while the bank rate affects the BOC’s business with commercial banks, the Overnight rate affects banks’ borrowing rate to other banks.
Brief History of Prime Rates in Canada
Bank of Canada Formed in 1935
The Bank of Canada was founded in 1935, operating from Ottawa’s Washington street to make decisions on the financial aspect of the Canadian economy. The BOC decides the Overnight target rate and bank rates in Canada and has the power to make changes at any time. Since its inception in 1935, it helped lead the rise from the great depression that cripled the world economy.
1935 – 1955: The Great Depression, World War II & Post War
From the 1930’s, the great depression and World War II had a significant impact on Canada’s economy causing strong of criticism of the country’s financial system. At the time prime rate in Canada which started at 2.5% in 1935 had by the end of 1955 fallen to 2.0%. Although there was sharp fall to 1.5% in 1945, Canada’s role in supplying natural and manufactured resources during the second world war help beef up its economy.
1977 – 1991: Global Oil Crisis
After Worldwar II, the Canadian economy continued to rise slowly along with the prime rate until it hit a high point of 10.28% in October 1978. The oil boom due to record high prices caused by the OPEC oil embargo saw the prime rise even further up to 20.03% in 1981 before falling steadily to 7.14% in March 1987.
1991 – 2008: Economic Recovery
During the Canadian economic recovery, the Bank of Canada introduced the inflation rate targeting to prevent the prime rate from falling below expectations.
2009 – 2017: The Great Financial Crisis
The great financial crisis of 2009 saw the BOC prime rate slump below 1% reaching a record low of 0.5%. Furthermore, the fall in oil prices in 2014 also contributed to Canada’s recession which also affected the rates causing it to fall from its recovery rate of 1.25% back to 0.75% in 2015.
2018-2022: COVID Rate Changes
After the great financial crises, the Canadian economy grew significantly and witnessed a slow rise in rate. Although the 2019 inflation prevented the BOC prime rate from increasing beyond 1.75% as of 2019, the COVID pandemic also caused a reversal that saw the BOC overnight rate plunge to 0.25% by the first quarter of 2020. As of today, the BOC rate still stands at 0.25%, while the Canadian bank prime rate is 2.45%.
Final Thoughts
From the start of prime rates in 1935 to the introduction of inflation rate targeting in 1991 and now, the Canadian economy has seen many up and downtrends that significantly affected the financial lending market. Today many points to the 1981 all-time highs as warnings of what’s possible in the sector as regards variable mortgage risks. But then, we are in a different time where there’s more control of what’s obtainable in the financial industry.
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