In Canada, the prime rate is currently 7.20%.
The prime rate is the interest rate that banks and other financial institutions charge their most creditworthy customers.
What Causes the Prime Rate to Change?
The prime rate changes mainly in response to the Bank of Canada’s (BoC) adjustment to its target for the overnight rate (sometimes called the policy interest rate).
The overnight rate is the interest rate that private banks charge when they lend to one another.
Therefore, to understand how and why the prime rate shifts, it’s crucial to know how and why the BoC changes its policy interest rate.
As explained in the Bank of Canada Act, the BoC’s role is to “promote the economic and financial welfare of Canada.”
Its primary responsibility is to manage Canada’s monetary policy by influencing the supply of money that circulates in the economy.
In general, the BoC likes to see inflation around 2%.
Therefore, if the economy grows too rapidly, it’ll raise its lending rate, also known as the bank rate, to curb inflation.
The bank rate is the interest rate private financial institutions incur when borrowing from the BoC.
Conversely, if the economy is in a slump and inflation dips below 2%, the BoC will lower its lending rate to stimulate more production and borrowing.
The effect increases the money supply, thereby boosting inflation.
So, why do these BoC rate adjustments trickle down to your local bank?
The reason is that private banks pay interest on money they borrow, just like any retail consumer.
Should their borrowing costs change, so will the rates they charge on loans they issue to their customers.
Private banks can choose between borrowing funds from the BoC or other private banks at the overnight lending rate.
They usually opt for the latter option because it’s cheaper.
At the time of this writing, the BoC’s lending rate is 4.75%, and the overnight rate is 4.5%.
Should the BoC lending rate shift, whether up or down, so will the overnight rate.
Let’s say the BoC raises its lending rate.
In that case, the change will result in a corresponding increase in the overnight rate.
As private banks borrowing costs rise, they’ll offset the extra expense by hiking their prime rate.
And since the prime rate acts as a benchmark for setting rates on variable-rate loan products, the banks’ customers will incur higher interest charges.
New fixed-rate loans will become more expensive as well.
The opposite occurs when the BOC slashes its lending rate: the overnight rate will drop, decreasing borrowing costs for private banks.
As a result, they’ll pass on these savings to their customers by charging lower rates on variable-rate loans.
They’ll also offer better deals on fixed-rate loans.
Did You Know?
Unique circumstances can trigger emergency policy rate adjustments. For example, during the COVID-19 pandemic, the BOC rapidly cut its lending rate to keep the Canadian economy afloat.
How Does the Prime Rate Affect Mortgages?
The impact that the prime rate has on mortgages and mortgage-related products depends on whether it’s fixed-rate or variable-rate.
Fixed-Rate Mortgage
An active fixed-rate mortgage remains unaffected by changes in the prime rate for its term.
The reason is that the rate you and your lender agreed upon at the beginning of the loan term is locked in.
For example, suppose you recently acquired a five-year fixed-rate mortgage at 5.75%, and the prime rate suddenly spikes.
In that case, you’ll continue to pay interest at the 5.75% rate until your mortgage term ends.
A fixed-rate mortgage, thus, shields you from rising rates for a specific time frame.
However, once it’s time to renew your mortgage, things change.
Your borrowing costs will increase if the prime rate is considerably higher than five years ago.
Since the prime rate is a benchmark for rates on all other loans, including fixed-rate mortgages, you’ll have no choice but to renew at a higher rate.
The same concept applies to first-time homebuyers looking to acquire a mortgage.
Lenders will offer either cheap or expensive financing depending on the current prime rate.
For this reason, homebuyers rush to lock in a fixed mortgage rate for as long as possible if they anticipate BoC rate hikes.
Variable-Rate Mortgage
A variable-rate mortgage is tied directly to the prime rate.
As such, any change in the prime rate will, in turn, affect a variable-rate mortgage.
Sometimes, the expression “floating rate” is used, as the interest rate is subject to change during the mortgage term.
Let’s assume the prime rate is 6%, and your newly acquired mortgage has a contract rate expressed as “prime + 0.45.”
Therefore, your current mortgage interest rate is 6.45%. If the prime rate rises to 6.5% six weeks later, your mortgage rate will increase to 6.95%.
Remember, however, that your payment amount will remain the same.
What will change is the portion of your payment allocated to interest versus principal.
In the above scenario, more of your payment will go toward interest charges rather than the principal.
The opposite will occur if your lender’s prime rate drops – a larger percentage will go towards the principal.
Adjustable-Rate Mortgage
The prime rate has the same impact on an adjustable-rate mortgage as it does on a variable-rate mortgage.
Should the prime rate rise, so will the interest rate you pay on your adjustable-rate mortgage.
The reverse is also true: a drop in the prime rate will result in a corresponding decrease in your adjustable mortgage rate.
However, unlike a variable-rate mortgage, your regular payments will change.
A hike in your lender’s prime rate will increase your mortgage payment’s size, while a cut will decrease it.
Home Equity Line of Credit (HELOC)
A HELOC is almost always a variable-rate product.
As such, any shift in your lender’s prime rate will affect the rate you pay on a HELOC.
Many HELOCs are structured as “Prime + 0.5%.” Therefore, if the current prime rate is 7.20%, your HELOC rate will be 7.70%.
Unlike mortgages, payments on HELOC are usually “interest only” for a set number of years (known as the draw period). As a result, you can forego paying the principal, which makes servicing a HELOC more manageable in an environment where rates are rising.
Still, if rates climb rapidly and it’s time to repay your principal, you may struggle to make the monthly payments.
Who Sets the Prime Rate?
Each lender sets its own prime rate.
When there’s a change in the target for the overnight rate, lenders will adjust their prime rate quickly, usually within a few days.
As a result, you’ll feel the impact of any prime rate change almost immediately on your variable-rate loans.
Is the Prime Rate the Same at All Lenders in Canada?
Generally, banks and other lending institutions settle on the same prime rate.
As a result, it doesn’t matter who you conduct your banking with – the prime rate will more often than not be the same everywhere.
Banks adjust their prime rate in unison because a single factor influences it: the BOC’s target for the overnight rate.
As the overnight rate shifts, the borrowing costs change for all of them simultaneously as they lend to each other at this rate.
Should a bank keep its prime rate the same following an overnight rate hike, it’ll earn a lower profit relative to their competition due to higher borrowing costs.
Alternatively, let’s say a bank retains its current prime rate after a reduction in the overnight lending rate.
In this scenario, they’ll lose a competitive advantage since their peers will offer their customers lower interest rates on loans.
Banks typically adjust their prime rate by the same amount as the change in the overnight lending rate.
However, they’re not obligated to do so – they may deviate by choosing a rate better aligned with their financial interests.
Fun Fact
When the BOC cut its policy interest rate by 25 basis points, some of Canada’s largest banks only reduced their prime rates by 0.15 basis points. This was a rare instance where banks didn’t fully match the BOC’s rate reduction.
Prime Rate History in Canada
After the Great Recession, the BoC kept its lending rate low to accommodate a recovering economy.
In 2010, the overnight rate was as low as 0.25%, resulting in a prime rate of 2.25%.
Late in the year, the overnight rate increased to 1%, where it remained until the end of 2014.
The prime rate, in turn, rose to 3%.
Though Canada’s economy was then on the road to recovery, a significant drop in oil prices caused turmoil and in response, the BoC cut its lending rate for the 2015-2017 time period, which caused the prime rate to dip as low as 2.7%.
The BoC again began to hike its lending rate in September 2017, driving the prime rate up to 3.95%.
Due to the COVID-19 pandemic, the BoC abruptly reversed course and slashed rates to support a devastated economy.
The overnight rate fell to 0.25%, resulting in a prime rate of 2.45%.
With the pandemic waning early in 2022, high inflation set in.
As a result, the BOC began a series of aggressive rate hikes to combat rising prices.
Frequently Asked Questions
- Is Canada’s Prime Rate going to increase?
- How often does the Prime Rate change in Canada?
Mark is passionate about educating people on how the financial markets work and providing tips to help them better manage their money. Mark holds a bachelor’s degree in finance from the Northern Alberta Institute of Technology and has more than a decade of experience as an accountant.
Outside of writing and finance, he enjoys playing poker, going to the gym, composing music, and learning about digital marketing.
