Why Does it Matter to Mortgage Borrowers?
Canadian mortgage borrowers have experienced stress over the past year due to increasing interest rates. News headlines commonly refer to the prime rate, noting the frequent increases in the prime rate and the impact it has on variable-rate mortgage borrowers. As a mortgage borrower, do you understand how the prime rate affects you?
6.70%
Current Prime Rate
What is the prime rate?
The prime rate is most commonly defined as the interest rate commercial banks charge their most credit-worthy customers. It serves as a benchmark rate for setting the rates on a variety of financial products, including mortgages, personal loans, and lines of credit. The prime rate is influenced by several factors, including inflation, economic growth, and the supply and demand for credit.
The prime rate is determined by the banks themselves, and it is typically set at a level that is 1.5 to 2.5 percentage points above the overnight lending rate set by the Bank of Canada. The prime rate is currently (as of May 8, 2023) 6.70%, the highest it has been in over twenty years.
While the current prime rate appears high to us today, that is because it had been unusually low over the past decade. The average Prime Rate over the past 50 years is 7.25%, compared to today’s Prime Rate of 6.70%.
How is the prime rate determined?
Each Canadian bank sets their own prime rate. They generally end up being the same rate, with no difference between the banks. Independent mortgage lenders do not set their own prime rate. They reference one or more of the big banks and use their prime rates as their reference prime rate.
The Bank of Canada's monetary policy is a key determinant of the prime rate even though it does not directly set it. The Bank of Canada uses its benchmark overnight lending rate to regulate the nation's economic growth and restrain inflation. The Bank of Canada influences short-term interest rates by adjusting the target for the overnight rate on eight fixed dates each year.
When the Bank of Canada changes the overnight rate, the Canadian banks usually change their prime rates within a couple days. They tend to move their prime rates by the same amount and in the same direction that the Bank of Canada moves the overnight lending rate.
How do banks use the prime rate?
Banks use the prime rate as a benchmark rate for a variety of financial products, including mortgages, personal loans, and lines of credit. The interest rate charged for these products is typically set at a margin above or below the prime rate. Most products will have a rate of Prime plus a margin but variable rate mortgages for the best borrowers are usually priced at Prime minus a margin. For example, a bank might offer a variable-rate mortgage at a rate of prime minus 1% (equal to 5.70% today). As the Prime Rate moves up or down the variable mortgage rate will move also, but the margin stays the same for the term of the mortgage.
How are variable rate mortgage rates set relative to the prime rate?
Variable rate mortgages are directly tied to the prime rate. When the prime rate goes up, so does the interest rate on a variable rate mortgage. Conversely, when the prime rate goes down, so does the interest rate on a variable rate mortgage. This means that borrowers with variable rate mortgages are exposed to interest rate risk, as their mortgage payments can increase if the prime rate increases.
The margin relative to the prime rate depends on market conditions, the risk profile of the borrower and the costs of lending. When market conditions are positive, the margin for the best borrowers can be as much as minus 1.50%. When market conditions worsen, that margin can be as small as 0.25% to 0.50%.
As an example, using today’s prime rate, the rate on a variable rate mortgage might be 5.70%:
6.70% - 1.00% = 5.70%
If the prime rate was reduced by 0.25% to 6.45%, the rate on a variable-rate mortgage would become:
6.45% - 1.00% = 5.45%
The margin of 1.00% stays the same for the term of the mortgage but the rate will change when the prime rate changes.
The prime rate is usually the same for all banks. They will use this base prime rate for pricing variable rate mortgages and the competitive difference in rate is the margin below the prime rate that they offer. However, there is one bank that does things differently. TD Bank uses a prime rate for mortgage lending that is equal to their prime rate plus 0.15%. They have been doing this since 2016. Borrowers should note this since TD needs to offer a larger margin discount to their prime rate to get you to the same rate being offered by other lenders.
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Is Today’s Prime Rate Historically High?
The prime rate fluctuates over time. There have been significant increases in the past, primarily due to central bank efforts to tame inflation, very similar to what happened in Canada in 2022. The current prime rate seems very high but is it really that high when compared to the past. The answer is yes, when you compare it to recent history. However, the business and interest rate cycles run over a long time period and when you look back further in history, today’s prime rate looks fairly normal:
| Prime Rate | BoC Overnight Rate | Difference | |
|---|---|---|---|
| 50 Year Average | 7.24% | 5.55% | 1.69% |
| 20 Year Average | 3.64% | 1.63% | 2.01% |
| 10 Year Average | 3.26% | 1.10% | 2.16% |
A 6.70% prime rate is much higher than recent history but relatively average when looking back over the long-term. Rates have steadily declined over the past 40 years, so it makes sense that recent average rates would be lower. That period of consistent decline appears now to be over.
Note also that the difference between the prime rate and the BoC overnight rate has increased over time. The long-term, 50-year average difference is 1.69%. That difference today is 2.20% (6.70% prime rate versus 4.50% BoC target overnight rate). Banks are now charging more for their prime rate than they did in the past.
What is the historic margin between variable mortgage rates and the Prime Rate?
The historic margin between variable mortgage rates and the prime rate has varied over time. In general, the margin tends to be a discount ranging between 0.5% and 1.5%, depending on market conditions and the risk profile of the borrower. During times of economic uncertainty or when credit conditions are tight, banks may offer less of a discount margin to account for increased risk.
Can anyone predict where the prime rate will go in the future?
Predicting where the prime rate will go in the future is difficult. It is influenced by a wide range of factors and, as we saw in 2022, can be subject to sudden changes. Some economists and analysts use models to forecast the future direction of interest rates, but these projections are often imprecise and subject to error. Ultimately, the direction of the prime rate will depend on a variety of economic factors that influence the rate setting policy of the Bank of Canada, including inflation, economic growth, and the supply and demand for credit.
Trying to predict the future direction of interest rates can be a risky exercise for a mortgage borrower. Just look at what happened to variable-rate mortgage holders in 2022. Many took out variable rate mortgages when rates were very low and are now experiencing financial stress due to higher rates. A fixed-rate mortgage would have been a better decision. Looking at a variable-rate mortgage as an opportunity to benefit from if rates decline without considering the risk if rates were to increase is a poor analysis. The best analysis for most of us is to find the rate that we can afford that we can lock-in for as long as possible. Making a bet on Interest rates is arguably inappropriate for a homeowner that is trying to secure financing for their house. It is a material risk. Assess your risk tolerance and understand what happens if your bet on rates does not work out. Taking interest rate risk is only appropriate for the minority of us that can afford to be wrong.
Most Recent Bank of Canada Prime Rate News
On April 12, 2023, the Bank of Canada held its policy rate - the target overnight rate – at 4.50%. Including their rate announcement on March 8, 2023, this is the second straight scheduled rate update where they have held the rate steady, indicating that the recent upward trend in rates is easing.
Inflation in Canada is easing somewhat (down to 5.2%) but it remains elevated above the 2% target set by the Bank of Canada. The Boc expects inflation to decline quickly to 3% by the mid-2023 and then decline further toward the 2% target by the end of this year. They expressed confidence in inflation declining in the next few months they acknowledge that reaching the 2% target may be difficult. The labour market remains tight, and some core inflation readings remain elevated. They are committed to reaching this goal, however, and state that the BoC “remains prepared to raise the policy rate further if needed”.
The next schedule policy interest rate announcement is scheduled for June 7, 2023.
Final Word
The Canadian bank prime rate plays an important role in the country's financial system, serving as a benchmark rate for a variety of financial products. While the Bank of Canada does not directly set the prime rate, it does have an indirect influence on it through its monetary policy. Banks use the prime rate as a basis for setting interest rates on loans and lines of credit, and borrowers with these variable -rate products, such as variable-rate mortgages, are exposed to interest rate risk. While predicting the future direction of the prime rate is difficult, understanding how it is determined and how it is used by banks and borrowers can help individuals make informed financial decisions.
If you have a variable rate mortgage you need to be aware that rates may continue to increase. We hear some advocates suggesting that rates will definitely come down in 2023. Do not listen to them. They do not know this. Manage your own affairs without trying to guess where rates are going. Like most “experts”, your predictions will likely end up being wrong. Variable-rate mortgages contain risk and are not for everyone.
If you are in the market currently for a mortgage, a fixed rate might be the best solution. With no exposure to interest rate risk during the term of the mortgage, a fixed-rate mortgage is the conservative choice for the majority of us that have a low risk tolerance.
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Prime Rate FAQs
What is the Bank of Canada?
The Bank of Canada is Canada’s central bank. The main function of a central bank is to promote the economic and financial welfare of Canada by overseeing monetary policy, influencing interest rates, issuing bank notes, and supervising Canada's financial institutions.
Established in 1934, the Bank of Canada operates as a Crown corporation under the Bank of Canada Act. As part of its operational role, the Bank of Canada is responsible for setting the target for the overnight interest rate. This is the rate at which major financial institutions lend and borrow money from each other on an overnight basis. The overnight rate affects the rates that the banks offer of credit products. As a result, it influences the cost of borrowing for consumers and businesses and, therefore, the overall level of economic activity in the country.
The Bank of Canada also plays a critical role in managing Canada's foreign reserves and providing financial services to the Canadian government. The Governor of the Bank of Canada is appointed by the government, reporting directly to the Minister of Finance.
Why Do Banks Change the Prime Rate?
Canadian banks change their prime rate is response to changes in the overnight rate that is set by the Bank of Canada. Banks set the prime rate at a margin above the overnight rate. As a result, when the overnight rate moves up or down, the prime rate will also move up or down.
How Often Does the Bank of Canada Change the Overnight Rate?
The Bank of Canada sets the target for the overnight interest rate eight times a year, in a series of announcements known as "Monetary Policy Reports" or "Interest Rate Decisions." These announcements are scheduled at the beginning of each year and are made by the Bank's Governing Council. In rare instances the Bank of Canada may also hold emergency meetings where changes to the overnight rate can be announced. The last time this happened was early in the covid pandemic.
| Bank of Canada 2023 Interest Rate Decision Announcement Dates |
|---|
| Jan 25 |
| Mar 8 |
| Apr 12 |
| Jun 7 |
| Jul 12 |
| Sep 6 |
| Oct 25 |
| Dec 6 |
If Inflation Declines Will the Prime Rate Decline?
There are no guarantees when it comes to interest rates, but the reason for the dramatic increase in the prime rate in 2022 was the dramatic increase in inflation. It is the widely held expectation in the market that once inflation is reduced to a level closer to the Bank of Canada’s 2% target level that the overnight rate would be reduced. If this were to occur, it would lead to a lower prime rate as well.
FAQs
How does Bank of Canada interest rate affect prime rate? ›
The prime rate is primarily influenced by the policy interest rate set by the Bank of Canada (BoC), also known as the BoC's target for the overnight rate. When the BoC raises the overnight rate, it becomes more expensive for banks to borrow money, and they raise their respective prime rates to cover the added costs.
How does the prime rate affect mortgage rates? ›The prime rate has little direct effect on most mortgage interest rates. Only home equity loans and lines of credit are typically tied to the "Wall Street Journal's" published prime rate. However, the prime rate does exert some indirect influence on many mortgage rates, particularly adjustable rate mortgages.
How does the Bank of Canada rate affect mortgage rates? ›The Bank of Canada doesn't set mortgage rates. But it does have some impact on them. When the economy is strong, we may raise this rate to keep inflation from rising above our target. Likewise, when the economy is weak, we may lower our policy rate to keep inflation from falling below target.
What is prime rate for mortgage in Canada? ›The prime rate has risen from 2.45% in March 2022 to the current prime rate of 6.95%.
What will happen to prime rate in Canada? ›The Canadian prime rate stays at 6.70% effective April 12, 2023. The prime rate is what major banks and financial institutions in Canada use to set interest rates for loans and lines of credit which also include variable rate mortgages.
How much of prime rate is expected to increase in Canada? ›| Time | BoC Rate | Prime Rate |
|---|---|---|
| End of 2024 | 3.75% | 5.95% |
| End of 2025 | 2.75% | 4.95% |
| 2026 - 2028 | 2.25% | 4.45% |
| This table is populated based on market conditions and information available as of June 1st, 2023. Use the most updated information to form your own judgment for your financial decisions. | ||
A lower prime rate typically leads to more activity in the market as people take advantage of the low rates to borrow and spend money. Conversely, when the prime rate goes up, this often slows down the economy and reduces inflation.
How does Fed interest rate affect mortgage rates? ›The Federal Reserve doesn't set mortgage rates, but its actions indirectly affect mortgage rates. As of its meeting of May 3, 2023, the Fed has raised a benchmark interest rate by a total of 500 basis points, or 5 percentage points, since the central bankers began raising interest rates in 2022.
When interest rates rise what happens to mortgage rates? ›When interest rates go up, mortgages become more expensive as the interest rate on mortgages also goes up. This makes it more costly for consumers to purchase a home. When homes are more expensive, the demand for them decreases.
What affects interest rates in Canada? ›While the Bank sets the key short-term interest rate in Canada, long-term interest rates are determined by structural changes in the global economy. As they did in most advanced economies, long-term interest rates in Canada fell in the 25 years before the COVID-19 pandemic.
Why does the Bank of Canada adjust interest rates? ›
The accumulation of evidence—across a range of economic indicators—suggests that excess demand in the Canadian economy is more persistent than we thought, and this increases the risk that the decline in inflation could stall. That's why we decided to raise the policy rate.
What is the mortgage rate forecast for Canada? ›Expectations for the benchmark rate at the end of 2024 range from a low 2.50% to 3.50%. The respondents also pointed to weaker housing markets as the top risk facing economic growth in Canada, followed by tighter financial conditions and tighter monetary policy.
What does prime rate mean in mortgage? ›The prime interest rate, also known as the “prime rate,” is the interest rate commercial banks charge their most credit-worthy business customers. It is a baseline rate upon which all floating rate loans are negotiated (for example, prime + 3%). The prime rate is set by financial institutions in a competitive fashion.
What is the difference between prime rate and interest rate? ›How does the prime rate affect you? While the interest rate on most financial products is dependent on the prime rate, the actual rate you receive is rarely the same exact amount. Typically, your interest rate is above the prime rate, but the amount can be greater depending on the lender.
What is prime rate on mortgage? ›The prime rate impacts current mortgage rates, as well as loan products. As it turns out, the prime rate equates to the best interest rate at which any given financial institution will lend money to its most creditworthy and trusted clients.
How high will prime rate go in 2023 Canada? ›Historical context: Mortgage rates will likely gravitate lower over the long term, to a historical trend in the low-mid 3% range. The market consensus on the mortgage rate forecast in Canada (as of June 8, 2023) is for the Central Bank to increase rates by 0.25% in July 2023.
Will mortgage interest rates go down in 2023? ›“[W]ith the rate of inflation decelerating rates should gently decline over the course of 2023.” Fannie Mae. 30-year fixed rate mortgage will average 6.4% for Q2 2023, according to the May Housing Forecast. National Association of Realtors (NAR).
What is the mortgage interest rate forecast for 2023 in Canada? ›On Wednesday, March 8th, 2023, The Bank of Canada announced that it will hold the key interest rate at 4.50%, for the first time in over a year. This is anticipated to continue until the end of this year, when the Bank of Canada is expected to begin lowering interest rates again to stimulate the economy.
How much will prime rate go up in 2023? ›| Date | Rate |
|---|---|
| May 4, 2023 | 8.25% |
| March 23, 2023 | 8.00% |
| February 2, 2023 | 7.75% |
If you're hoping interest rates will go down sooner rather than later this year, you might be disappointed. Several economic projections indicate that interest rates will only begin to go down sometime during the final quarter of 2023 or in the first quarters of 2024.
How high will interest rates go in 2023? ›
So far in 2023, the Fed raised rates 0.25 percentage points twice. If they hike rates at the May meeting, it is likely to be another 0.25% jump, meaning interest rates will have increased by 0.75% in 2023, up to 5.25%.
Who benefits from prime rate? ›The prime rate is the current interest rate that financial institutions in the U.S. charge their best customers. These customers have excellent credit, and are eligible for this optimal rate because their loans carry the lowest risk for their financial institutions.
How does raising the prime rate help inflation? ›Rising interest rates can stave off inflation
As mentioned before, raising interest rates helps inflation by reducing consumer borrowing and spending, thereby cooling off demand for goods and services. This then helps lower prices and reduce inflation.
The Federal Reserve is expected to raise the fed funds rate by 25 basis points to a range of 5%-5.25% during its May 2023 meeting, marking the 10th increase and bringing borrowing costs to their highest level since September 2007.
Why do mortgage rates go down when Fed raises rates? ›That's because rattled investors began looking toward the relative security of government bonds. With interest rates high and economic uncertainty looming, bonds seem like a safe place to park assets. That's pushing up bond prices, which tends to lower fixed mortgage rates.
Do mortgage rates go down when Fed raises rates? ›However, the Fed does set one crucial rate: the federal funds rate. This rate can have impacts that trickle down to sway rates on consumer lending products like credit card APRs, savings account APYs, auto loan rates, and even mortgage rates.
Why did my mortgage go up if I have a fixed rate? ›A fixed rate means the principal and interest payment on your loan will never change. However, your monthly mortgage payment also includes an escrow payment for real estate taxes and insurance premiums, which do change periodically.
Is high inflation good for mortgage holders? ›Is high inflation good news for homeowners? Unfortunately, high inflation is rarely a good thing for those with mortgages. If interest rates subsequently rise, this pushes up mortgage rates too. But not everyone will see an instant increase in their monthly repayments.
Is it better to buy when interest rates are high or low? ›Key Takeaways. Your interest rate becomes more important if you plan to live in your home for more than five years because you'll be paying it for a longer period of time. Buying a home at a lower price but at a higher interest rate can be workable if you can refinance the mortgage in the future to reduce your rate.
What does higher interest rates mean for home buyers? ›They determine how much consumers will have to pay to borrow money to buy a property, and they influence the value of real estate. Low interest rates tend to increase demand for property, driving up prices, while high interest rates generally do the opposite.
What controls interest rates Canada? ›
The Bank carries out monetary policy by influencing short-term interest rates. It does this by adjusting the target for the overnight rate on eight fixed dates each year.
Did Canadian interest rates go up? ›Bank of Canada raises policy rate 25 basis points, continues quantitative tightening. The Bank of Canada today increased its target for the overnight rate to 4¾%, with the Bank Rate at 5% and the deposit rate at 4¾%.
When did Bank of Canada change interest rates? ›| Date | Target (%) | Change (%) |
|---|---|---|
| April 13, 2022 | 1.00 | +0.50 |
| March 2, 2022 | 0.50 | +0.25 |
| January 26, 2022 | 0.25 | — |
| December 8, 2021 | 0.25 | — |
The central bank has raised its benchmark rate by 4.5 percentage points since last March. Many adjustable-rate mortgage holders likely expected the Bank of Canada's January rate hike to be the last of its current tightening campaign, and for rates to start declining in late 2023 or early 2024, Mr. Laird said.
What will interest rates be in 2024 Canada? ›The bank's survey of market participants, the second iteration of the poll first released in February, showed a median of the participants forecasting interest rates dropping to 3.0 per cent by the end of 2024.
What is prime rate in simple words? ›The prime rate is an interest rate determined by individual banks. It is often used as a reference rate (also called the base rate) for many types of loans, including loans to small businesses and credit card loans.
What is prime rate for dummies? ›The prime rate is the interest rate that commercial banks charge creditworthy customers and is based on the Federal Reserve's federal funds overnight rate. Banks generally use fed funds + 3 to determine the current prime rate.
Why is prime rate higher than mortgage rate? ›Unlike the prime rate, mortgage rates are determined by economic factors. If the Federal Reserve increases the supply of money circulating in the economy, market interest rates are pushed lower to encourage economic activity. The opposite is true if the Federal Reserve shrinks the supply of money.
What is the highest prime rate has ever been? ›What was the highest prime rate? The highest prime rate was 21.5%, reached on December 19, 1980.
What is the highest prime mortgage rate ever? ›What is the highest prime rate in history? The highest prime rate in history was on December 19, 1980, standing at a record-breaking 21.5%. The Federal Reserve set the federal funds rate guidance to sustain the 21.5% prime rate until January 1, 1981.
Will Canadian banks increase prime rate? ›
Royal Bank of Canada, TD Canada Trust, Canadian Imperial Bank of Commerce (CIBC), Bank of Montreal, National Bank of Canada and Bank of Nova Scotia all said they were increasing the prime rate by 25 basis points to 6.95 per cent from 6.70 per cent, effective June 8, 2023.
Does prime rate vary from Bank to Bank? ›One interesting feature is that the prevailing prime rate typically is uniform across all banks—unlike deposit interest rates banks pay, which often vary considerably from bank to bank depending on funding needs and portfolio considerations.
How often does the Bank of Canada change the prime rate? ›The Bank carries out monetary policy by influencing short-term interest rates. It does this by adjusting the target for the overnight rate on eight fixed dates each year.
Does prime rate affect interest rates? ›If the prime rate rises, the interest rates on your loans and adjustable-rate credit cards will rise as well. Second, the prime rate affects liquidity in the financial markets. When the rate is low, liquidity increases.
What is the prime rate forecast for Canada in 2023? ›Historical context: Mortgage rates will likely gravitate lower over the long term, to a historical trend in the low-mid 3% range. The market consensus on the mortgage rate forecast in Canada (as of June 8, 2023) is for the Central Bank to increase rates by 0.25% in July 2023.
What does prime rate mean in Canada? ›The prime interest rate, also known as the “prime rate,” is the interest rate commercial banks charge their most credit-worthy business customers. It is a baseline rate upon which all floating rate loans are negotiated (for example, prime + 3%). The prime rate is set by financial institutions in a competitive fashion.
What is the Bank of Canada prime rate forecast for 2023? ›The Bank of Canada unexpectedly raised the target for its overnight rate by 25bps to 4.75% in June 2023, after pausing the tightening campaign in the previous two meetings, while markets were anticipating interest rates would be left on hold.
What happens when prime rate increases? ›As a result of the Fed changing the federal funds rate, the prime rate also changes and your credit card APR will fluctuate accordingly — meaning an increase in the federal funds rate and prime rate results in an increase in your card's APR.
What is the projected prime rate for 2023? ›| Date | Value |
|---|---|
| June 30, 2023 | 6.47% |
| March 31, 2023 | 6.50% |
| December 31, 2022 | 6.50% |
| September 30, 2022 | 6.50% |
The Federal Reserve can adjust its monetary policy to encourage interest rates to stay within this target range. Banks generally add 3% to the federal funds target rate when setting the prime rate for their customers.
What is the highest mortgage rate in Canada history? ›
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 crisis, Canadian borrowers have seen several changes in their mortgage journey.
What is the highest interest rate in Canada history? ›Deposit Interest Rate in Canada averaged 5.64 percent from 1975 until 2023, reaching an all time high of 22.06 percent in August of 1981 and a record low of -0.10 percent in October of 2020.
Will interest rates go down in 2023? ›Along those lines, organizations like Fannie Mae and the Mortgage Bankers Association forecast that the average rate on 30-year fixed-rate mortgages will decline throughout 2023, continuing into the first quarter of 2024.
Does prime rate go up in recession? ›Interest rates typically fall once the economy is in a recession, as the Fed attempts to spur growth.