In recent years, the economic situation around the world has shaken a lot, which of course has had an impact on Canada’s prime rate. A couple of years ago, the prime rate was 2.45%, but recently this has risen to 3.20%. What is the prime rate, what does it affect, how it has changed in recent years, and what are the reasons for its changes – this article will tell you all about it.
What is the prime rate in Canada?
The prime rate is the regular interest rate in Canada that most financial lending institutions use as the minimum amount for their floating-rate products. These include:
- lines of credit and cards;
- purpose and consumer loans;
- equity lines of credit.
How is Canada’s prime rate formed?
Financial institutions have the right to change the minimum interest rate if the key interest rate set by the Bank of Canada increases or decreases. It is also known as the target overnight rate. It is the rate at which the central bank lends to other banks. The size of the key interest rate depends directly on the inflation rate, economic indicators, and the country’s monetary policy.
Currently, the amount of the target overnight rate is 1%. The change came on April 13, when the Bank of Canada announced an increase in the benchmark rate from 0.5%. This is the second rate hike in 2022. At the beginning of the year, the key rate was set at 0.25%. It has remained within these limits since the pandemic began in January 2020. Of course, this situation could not help but affect the Canadian prime rate hike today.
For example, when the prime rate was 0.5%, the prime interest rate was 2.70%. After the overnight rate rose to 1% (by 50 basis points), the prime rate also increased by 50% and is now set at 3.20%.
The value of the key rate can change only at certain times. Thus, there are 8 specific dates in 2022 on which the Bank of Canada will formally announce the prime rate. Three announcements we have already heard, with the following dates set for June 1, July 13, September 7, October 26, and December 7. All analysts in Canada are looking forward to these days.
How has the prime rate and key rate changed over the years
The history of the Canadian prime rate began in December 2007, when it reached its highest level. The regular rate at the time was 6% and the key rate was 4.25%. After 2007, the rates have seen a downward trend as shown in the table below:
|Month/year||Overnight (%)||Prime rate (%)|
Why Prime Rate Changes So Much
As mentioned above, the prime rate is directly related to the overnight rate. It is set by the central bank of Canada, based on the economic situation in the country, in order to promote financial well-being. Thus, if the economy is booming, the main lending institution can raise the key interest rate to prevent the rising prices of goods and services. Experts predict that the nation’s leading banks will raise the prime rate in the coming weeks.
When there are downturns in the economy or any unplanned circumstances that will inevitably affect Canada’s financial situation, the central bank lowers the overnight rate. Thus, it supports other lending institutions and stabilizes the financial situation in the country. As was seen in 2008, when the Bank cut the rate to a record low of 0.25% during a severe economic crisis.
How I might be affected by a rise or fall in the prime interest rate
As we indicated earlier, your prime rate level affects your charges on loans, cards, and lines of credit if you have a floating interest rate under the terms of your contract. For different loan products, the level of interest rates will vary, depending on the bank’s terms and conditions. Let’s take a closer look at several loan options.
In Canada, fixed-rate and floating-rate mortgages are the most common. In the case of the first option, the value of the prime rate will not affect the client if he has already taken out a loan under certain conditions and made the mandatory payments. However, if you are just getting a mortgage, the prime rate will certainly affect the total cost of the loan and the interest rate for using it.
If you have a mortgage with a floating rate, however, prime will be the deciding factor in interest charges. Usually, it looks like “initial -0.45%” and every 5 years the rate will be recalculated. In these situations, you may incur minimal costs if the prime rate is reduced. Otherwise, you’ll have to overpay a decent amount for the loan.
If you took out a car loan with a floating interest rate, get ready that the number of your mandatory payments will vary. The fact is that it is tied to the prime rate and will depend on the terms of your lending institution. We recommend that you clarify all of these issues before signing a loan agreement. Only after that ask yourself whether such a car loan will be profitable for you.
Home equity lines of credit
If you use home equity lines of credit and have access to a HELOC, you will feel the changes in prime rates more tangibly. The cost of these products is directly related to the dynamics of the prime interest rate. To attract customers, banks usually use different slogans in their advertising. For example, “prime +1%”.
The terms and conditions of credit cards may also specify a floating interest rate. Accordingly, its value also depends directly on the prime rate. The following slogans are used to attract customers: “prime rate plus 9.99%”, “prime rate plus 4 to 10%”, etc.
One way or another, the prime rate is very important to many Canadians. It directly affects the cost of your loans in general, especially if they have a floating interest rate. If you are thinking about getting a loan, think long and hard about the pros and cons. Remember there will always be a risk, and no one can predict if the prime interest rate will rise or fall tomorrow. So, take the loan very seriously and carefully! Good luck to you!