If you are looking for a home, there is little doubt that you have heard about Canada’s Prime Rate. As of May of 2020, the prime rate was 2.45 percent. That is the lowest that it has been since the financial crisis of 2008.

The Bank of Canada dictates this rate, and they have pushed hard to cut rates since the COVID-19 pandemic took hold. The goal is that people would have access to enough cheap credit that they would be able to weather the potential financial fallout of the pandemic.

Better understanding the prime and how it works can give you a leg up when it comes to finding a mortgage. After all, getting the best rates is one of the main goals. And those rates are intrinsically tied to the prime.

What is the Prime Rate?

The Prime rate, also formally known as the prime lending rate, is the number used to set interest rates. These rates dictate the interest attached to several different loans, and the rate can fluctuate (more on that later).

Loans that tie to the prime rate include things like variable-rate mortgages and variable-rate car loans primarily. It also impacts Home Equity Lines of Credit (HELOC) and certain types of credit cards. The most common types of credit cards impacted are balance transfer cards that have variable APRs.

As the prime rate moves up and down, so will the interest on any of those types of loans. Additionally, banks tend to offer better or worse deals on some of their fixed-rate loan products, all depending on the prime.

There is also the question of how the prime rate gets set, what the overnight rates have been, and all of the pertinent questions about the prime.

Why Does the Prime Rate Move?

The Bank of Canada is the central bank for the country. Its job is to mandate and promote the financial and economic welfare of Canada. To do that, it has to modify its targets for the overnight rate based on the performance of the economy and any inflation forecasts.

Should the economy be ballooning, the Bank of Canada may raise the target for the overnight rate to get people to spend less. It would also want to raise the target for the overnight rate to keep prices from inflating to enormous heights. Following suit, the top Canadian banks would likely raise their prime lending rate over the next few weeks.

If the economy is in a weakened state or inflation has slowed down to lows considered undesirable, the Bank of Canada will generally lower their overnight rate. There are also exceptional circumstances – the coronavirus outbreak being a great one – that can potentially lead to emergency rate cuts as well.

In a press release dating back to March, the Bank of Canada explained their most recent overnight rate cut. It essentially came down to the abrupt decline of world oil prices in the face of the COVID-19 pandemic. The hope was that cutting the overnight rate would minimize any long-lasting damage to the overall structure of the Canadian economy.

Who Sets the Prime Rate?

Each of the banks in Canada sets its prime. But the five biggest banks tend to all have the same number between their rates. The five biggest banks in Canada are:

• Bank of Montreal (BMO)
• Bank of Nova Scotia (Scotiabank)
• Canadian Imperial Bank of Commerce (CIBC)
• Royal Bank of Canada (RBC)
• Toronto-Dominion Bank (TD)

The reason for this policy is that the prime has a heavy influence by something known as the Bank of Canada’s policy interest rate. It is also known as the target for the overnight rate. It is what the major banks charge for any one-day loans that happen between one another.

Whenever the Bank of Canada raises the overnight rate, it becomes more expensive for these banks to borrow money. In accordance, they raise their prime rates to cover those additional costs. They cover it by pulling in a higher interest rate from the customer.

On the other hand, when the Bank of Canada drops that overnight rate, the banks will usually follow suit by lowering their rates by the same number. Here are some of the changes in both Canada’s prime rate as well as the overnight rate.

The Prime Rate and Mortgages

Where we are most familiar with the prime lending rate, however, is in the mortgage industry. In Canada, the two most common types of mortgages are fixed-rate and variable-rate mortgages, and both have different interactions with the prime lending rate.

If you have an active fixed-rate mortgage, changes in the prime will not impact it. After all, that is what makes it fixed: it has protection from changes in the prime lending rate. For new borrowers, though, the mortgage rates offered to them would generally go either higher or lower depending on the movement of the prime lending rate.

In contrast, variable rate mortgages walk in step with the rate the whole way. If you have a five-year variable rate mortgage, your quote may look something like “prime – 0.50%”. If the rate is 3.00 percent, that would mean that your rate would be 2.50 percent for that variable rate mortgage.

Variable-rate mortgages tend to have lower rates than fixed-rate mortgages. The low rates are primarily due to the uncertainty behind them. In theory, the rates over the life of your mortgage and you could save money compared to a fixed rate.

Should that rate rise, though, you could be staring down a substantially larger monthly payment. You pay more for a fixed-rate mortgage for the security and peace of mind that it provides.

The Savings Of Going with Fixed Mortgage Rates

It is safe to say that your mortgage will likely be the largest financial undertaking that you will ever have. So, if you have the best-fixed mortgage rates, you could save thousands of dollars over that 5-year term.

Even a slightly lower rate can result in major savings, particularly early on in the mortgage. An example would be having a $500,000 mortgage and a 25-year amortization period. The interest rate being 3.00%, you would pay nearly $70,000 of interest over those five years.

Drop the interest to 2.75%, meanwhile, and the interest drops down to $63,000. That is a savings of $6,000 with just a 0.25% change in interest over that 5-year term. Those savings are nothing to scoff at.

Get the Best Rates with SaskEquity

The best way to get the best rates is to contact SaskEquity today. Our dedicated team will help you to understand the prime lending rate and how it can impact your search for the right mortgage.

Having questions is a very normal thing. Don’t go through the process of looking for a mortgage alone. Enlist the help of some of the best that the industry has to offer. Get the peace of mind that you deserve.