The Complete Guide to the Prime Rate in Canada

The prime rate: you will undoubtedly hear about this indicator when choosing a variable rate mortgage. The prime rate refers to the lowest interest rate for a variable rate mortgage. Lenders can offer a prime rate loan to the most creditworthy borrowers. The prime rate also serves other functions. It is also a base that allows banks and other mortgage institutions to set the rates for various variable rate credits. Understanding the mechanism of the prime rate is essential: this concept helps borrowers make decisions suited to better management of their finances. What should you know about the prime rate? Discover key information on the subject.

What is the prime rate in Canada?

Banks and financial institutions in Canada use an indicator called the prime rate. This rate is the reference taken into account for setting the interest rates displayed for financing offered to borrowers, such as variable rate loans and lines of credit, including variable rate mortgages. The prime rate differs from the posted rate for, say, a variable interest rate mortgage. The posted rate refers to the indicator that banks announce to their customers. It is, as a rule, higher than the prime rate due to the margin added by lenders as a consideration for the financing.

The difference between the posted rate and the prime rate is generally a few percent, for example 2 to 3%. With a prime rate of 6.7% in June 2023, for example, the posted rate for a variable rate mortgage could start from 8.7%. A borrower with a good credit score could thus benefit from a mortgage with this rate. The gap between the prime rate and a posted rate also varies depending on several factors. It depends, for example, on the type of loan, but also on the applicant’s credit score and market conditions at the time of the credit application. Borrowers with a poor creditworthiness score can expect a contract with an interest rate higher than 8.7%.

The prime rate is based on an indicator set at the Bank of Canada level: the key interest rate, itself influenced by factors such as the evolution of inflation and the overall economic situation of the country. When the Bank of Canada decides to increase its key rate, banks and lending institutions follow suit: they apply an increase to their prime rate. These variations can have a repercussion on your finances if you have variable rate loans or lines of credit. In this case, when you repay a variable rate mortgage, an increase in the prime rate means that the amount of your monthly mortgage payments is also revised upwards.

What is the prime rate used for?

Knowing the mechanisms that influence the rise or fall of rates is important, especially for a borrower considering taking out a mortgage with a variable rate. When it is variable, the interest rate of a mortgage has a direct link with the prime rate. Its fluctuation is indeed modeled on the evolution of the prime rate.

The prime rate is therefore paramount; it is one of the main tools used by banks and lending institutions to set the interest rates for various financing products. The main loans for which monitoring the prime rate is recommended are notably variable rate auto loans, variable rate mortgages, as well as certain types of credit cards and lines of credit.

When the prime rate increases, the interest rates on these loans and lines of credit also rise. Borrowers are then obliged to pay more interest on their debts.

The prime rate is an important tool that relies on the key rate issued by the Bank of Canada to manage inflation, or the overnight financing rate. When the Bank of Canada decides to increase its key rate, it is followed by a rise in the prime rate. It consequently becomes more expensive to borrow money, which can help slow down the economy and reduce price increases.

The prime rate can also have a significant influence on consumer finances. When the prime rate rises, it is more expensive to borrow money through a mortgage or auto loan. An increase in the prime rate can make it more difficult for borrowers to realize projects and can put a strain on their budget.

The evolution of the prime rate in Canada

The prime rate has been rising since March 2022 in Canada. The Bank of Canada raised its key rate over the following months, taking it from 0.25% to 4.50%. Consequently, the prime rate also increased, going from 2.45% to 6.7%.

The Bank of Canada increases its indicator to control inflation. In the country, inflation hit a 30-year record, announced at 8.1% in June 2022. The Bank of Canada estimates that by increasing the key rate, it can slow down the economy and bring inflation back to 2%.

Over the past 15 years, the evolution of the prime rate shows significant fluctuations. The prime rate was relatively stable between 2005 and 2007, hovering around 6%. In 2009, the Bank of Canada began to bring its key rate down to one of its lowest levels, at 2.25%.

In 2010, a new increase was observed, to 3%. During the first half of this decade, the level of the prime rate remained stable. Starting in 2015, the Bank of Canada reduced its key rate to stimulate the economy, affected by the fall in oil prices. This rate cut led to a decrease in interest rates for borrowers, but it also reduced investment returns.

The prime rate was then pulled upwards, as the key rate went from 2.7% in 2017 to 3.95% in 2020. This increase led to a surge in interest rates for borrowers and resulted in an increase in the cost of loans. Between February 2020 and February 2022, the key rate was again at its lowest, remaining stable for 2 years around 2.5%.

How does the prime rate impact the mortgage rate?

Fluctuations in the prime rate particularly affect variable rate mortgages. This type of loan operates on a specific mechanism that is influenced by the prime rate. Before signing the mortgage financing contract, the financing organization informs you that your variable interest rate equals the prime rate plus or minus a percentage value. Since the current prime rate is 6.7%, if your broker negotiates a mortgage for you at the prime rate plus 1%, the interest rate for your loan will therefore be 7.7%.

• In the case where inflation reduces and economic activities improve in a few months or in a few years, the Bank of Canada could revise the key rate downwards. The prime rate could, for example, fall back to 4.7%. The variable interest rate of your contract should be directly impacted, as it would drop to 5.7%, leading to a decrease in your interest fees and thus the amount of the monthly payment you repay. Conversely, when the prime rate increases to 7.7%, the rate of your mortgage loan rises to 8.7%, thereby increasing the interest you have to pay.

The fluctuation of a variable rate mortgage’s rate decreases or increases according to the evolution of the prime rate. The consequences can be significant on your finances when the variations in the prime rate are major. On the other hand, the impact on the amount of monthly payments for a mortgage loan is minimal in case of slight changes in the prime rate.

• If inflation persists and skyrockets, the Bank of Canada will have no choice but to continue increasing its key rate, which should cause the prime rate to jump once again. The monthly amount to pay to repay a mortgage could thus increase once more. Conversely, when the prime rate falls because the Bank of Canada has lowered its key rate, borrowers gain enormously by seeing the interest on their mortgage reduce and the amount of their monthly payment decrease.

How does the prime rate influence credit card rates?

Since the prime rate is an interest rate that Canadian banks use to set their own rates, its decrease can have an impact on the rates of the credits and loans they offer. Credit cards generally have higher interest rates, compared to other types of loans, such as mortgage financing or consumer credit. This situation is due in part to the unsecured nature and ease of access of credit cards.

The evolution of the prime rate can have consequences on the interest rate of credit cards. When the prime rate falls, financing institutions can reduce the interest rates on the credit cards they offer. This option rests solely on a decision by the banks themselves, as they can also choose not to reduce the interest rate of their credit card in response to a drop in the prime rate. Similarly, when the prime rate increases, financial institutions may decide to increase the interest rates of their credit cards, which will make it more expensive for borrowers to repay their balance.

To best manage your credit card debt when the prime rate rises, a few steps should be followed:

• Pay off your credit card balance as quickly as possible;
• Pay more than the minimum payment each month;
• Ask your credit card issuer for a lower interest rate;
• Consolidate your debts into a personal loan with a lower interest rate.

Thanks to these solutions, you can minimize the impact of the prime rate on your credit card debt.

The prime rate of institutions in Canada

The prime rate is generally the same for all banks and mortgage institutions in Canada. The posted rate for variable rate mortgages can be different from one bank to another:

What is the BMO prime rate?

The prime rate at the end of May 2023 is 6.70% at BMO bank. The posted interest rate for variable rate mortgages starts at 6.50%.

What is the CIBC prime rate?

The prime rate at the end of May 2023 is 6.70% at CIBC Bank. The posted interest rate for variable rate mortgages starts at 6.50%.

What is the RBC prime rate?

The prime rate at the end of May 2023 is 6.70% at RBC bank. The posted interest rate for variable rate mortgages starts from the prime rate – 0.2%, i.e., from 6.50%.

What is the National Bank prime rate?

The prime rate at the end of May 2023 is 6.70% at the National Bank. The posted interest rate for variable rate mortgages starts at 6.74%.

What is the Desjardins prime rate?

The prime rate at the end of May 2023 is 6.70% at Desjardins. The posted interest rate for variable rate mortgages starts at 6.50%.

Conclusion

The prime rate is an important concept for borrowers and lenders. This interest rate is the most attractive rate that Canadian banks can offer their customers for variable rate loans, such as lines of credit, mortgage credits, and personal loans. The prime rate also affects the cost of borrowing. Since it depends on the key rate, its fluctuations can have significant repercussions on the cost of loans. The Bank of Canada regulates the country’s economy by setting the key rate, which is the interest rate for the funds it lends to commercial banks. When the key rate increases, the prime rate and interest rates on loans and mortgages also rise. If the key rate decreases, interest rates fall. The prime rate is therefore of crucial importance for borrowers interested in variable rate loans.