If you are in the market applying for a mortgage, car loan or any sort of personal loan in Canada. You will hear the words “Prime Rate” quite a lot. Your mortgage or loan advisor might tell you things like “Prime plus one” or “Prime minus 0.5” and this might go right over your head, but it is not too complicated. This short article will explain what a prime rate is as well as help you understand how the prime rate directly affects your regular loan payments.
What Is the Prime Rate?
The prime rate in Canada is currently set at 2.45% (Updated Jan 2021). This rate is also referred to as the “prime lending rate” and it is the annual interest rate that all Canadian financial institutions and major banks use to set the interest rate when you apply for a variable loan, variable mortgage or similar loan. If this prime rate goes up, you will pay more interest on top of your principal amount in your loan payments and if this prime rate goes down you will pay less interest on top of your principal amount in your loan payments.
Here is an example to understand how the prime rate works in Canada and how it affects you when you are getting a loan:
Johnathon goes to RBC (a major bank in Canada) to apply for a mortgage on a new home he wants to buy. The mortgage advisor at RBC advises Johnathon that the current Prime Rate at RBC is 2.45% but if he signs up today, he can provide Johnathon a discount of 0.5% and get his mortgage approved for him at a rate of 1.95% or in other words “Prime minus 0.5”
You should think of the prime rate as the bottom layer of a cake that other interest rates are based on and stack on top of. As the prime rate moves up or down, so too does the rate of interest you pay on your loan. All kinds of loans in Canada are based on this rate, including certain mortgages, car loans, personal lines of credit, and even some credit cards.
How Is the Prime Rate Set?
The prime rate is indirectly set by the Bank of Canada (BoC). While each bank technically sets its own prime rate, the rate they set is principally influenced by the policy interest rate set by the Bank of Canada (BoC), also known as the Bank of Canada’s target for the overnight rate. Just like how if a bank raises their prime rate it gets more expensive for you to borrow money for a loan. Similarly, if the Bank of Canada (BoC) raises the overnight rate, it becomes more expensive for the banks such as RBC, CIBC, TD etc. to borrow money, and they raise their respective prime rates which they are charging you to cover the added costs. Equally if the Bank of Canada (BoC) lowers their overnight rate, the banks usually lower their prime rates by the same amount.
Key focus on the word “usually” — on occasion some banks are greedier than others and even if the Bank of Canada (BoC) rate drops, the banks don’t always pass on the full discount to their customers.
Here is an example to understand how the Bank of Canada’s overnight rate directly affects the prime rate which you pay when applying for a loan:
Johnathon is thinking to buy a rental property to earn passive rental income. He goes to TD Bank to meet with mortgage advisor to get a mortgage quote. The mortgage advisor advises him that The Bank of Canada’s (BoC) overnight rate is 0.25% and most major banks, including TD have set their respective prime rate at 2.45%. Johnathon decides to maybe postpone his rental property purchase as the total loan amount he would pay per month was out of his budget. A few months later Johnathon goes back to TD Bank to get another quote and he is very disappointed to learn that the Bank of Canada’s (BoC) raised their overnight rate to 1.00% so TD Bank also raised their respective prime rate to 3.00%. Johnathon regrets that he should have locked in his mortgage in his first visit.
Can You Forecast the Prime Rate?
This is the golden question and a whole mortgage advisor industry is built around this. Will mortgage rates go higher? Lower? Stay the same? The honest answer is nobody, but the Bank of Canada (BoC) really knows where the overnight rate and therefore resultingly the prime rate will go.
The overnight rate is an indicator of how well or poorly the Canadian economy is functioning. If the economy is booming the Bank of Canada (BoC) will usually raise their overnight rate but if the economy is showing signs of slowing down the Bank of Canada (BoC) usually cuts their overnight rate to provide some relief to banks and therefore to Canadians who are applying for loans. This makes the cost of borrowing cheaper and therefore helps to get the economy spinning again.
But keep in mind as a consumer your primary focus is on the prime rate and not the Bank of Canada’s (BoC) overnight rate. It is the Prime Rate that affects how affordable or unaffordable a loan will be for you and what will be your cost to borrow money. That said the prime rate in most cases follows the overnight rate quire closely. If the Bank of Canada sets the overnight rate 0.25% higher you can expect that almost instantly the prime rate at all major banks across Canada will also be 0.25% higher.
Historical Prime Rate in Canada
This chart shows the prime rate over time, starting in 2004. You can see that the prime rate fluctuates quite regularly based on the financial climate of the world. For example you can see in 2008 when Canada went into a recession due to the global financial crisis, the prime rate fell from 5.75% at the start of 2008 to 2.75% at the start of 2009.
|March 31, 2020||2.45%|
|March 18, 2020||2.95%|
|March 6, 2020||3.45%|
|October 25, 2018||3.95%|
|July 12, 2018||3.70%|
|January 18, 2018||3.45%|
|September 7, 2017||3.20%|
|July 13, 2017||2.95%|
|July 24, 2015||2.70%|
|February 2, 2015||2.85%|
|September 8, 2010||3.00%|
|July 20, 2010||2.75%|
|June 2, 2010||2.50%|
|April 22, 2009||2.25%|
|March 04, 2009||2.50%|
|January 21, 2009||2.75%|
|December 10, 2008||3.25%|
|October 22, 2008||4.00%|
|October 9, 2008||4.25%|
|April 23, 2008||4.75%|
|March 05, 2008||5.25%|
|January 23, 2008||5.75%|
|December 5, 2007||6.00%|
|July 10, 2007||6.25%|
|May 24, 2006||6.00%|
|April 25, 2006||5.75%|
|March 7, 2006||5.50%|
|January 25, 2006||5.25%|
|December 6, 2005||5.00%|
|October 19, 2005||4.75%|
|September 7, 2005||4.50%|
|October 20, 2004||4.25%|
Share an Infographic Version of This Post!
Please include attribution to YourFirst.ca with this graphic.