What is a prime rate and how does it affect your mortgage decisions?
It's both an interest rate and an economic device. Here's what you need to know.
Bank prime rates rise or fall depending on the economic temperature — and as conditions heat or cool, so do your mortgage costs.
The Bank of Canada adjusts bank prime rates through its policy rate to manage economic stability. A higher prime rate cools down borrowing and spending, while a lower one heats them up again to revive a sluggish economy.
Yet a higher prime rate means you'll likely pay more interest on your mortgage. And a lower prime rate can mean better home affordability.
Let's take a closer look.
2.25% – Bank of Canada Policy Rate
4.45% – Bank Prime Rate
Note: The above prime rate reflects the rate most Canadian banks and mortgage lenders use. Bank prime rates usually adjust within a day or two of a BoC rate change. To keep up with the latest changes, read our Rate Forecast blog.
A prime rate, also called a bank prime rate, refers to the interest rate banks use to set other interest rates, including mortgage rates. It's the rate banks charge their most creditworthy clients, typically large corporations.
The prime rate is tied to the Bank of Canada's (BoC's) policy rate, which can change or stay the same at the eight pre-scheduled rate 'dates' during the year when the central bank decides whether to heat or cool economic conditions.
The prime rate 'floats' and directly affects other floating interest-rate products, like variable-rate mortgages and HELOCs (home equity lines of credit). It also indirectly affects the fixed-mortgage-rate market.
A higher prime rate usually means that all interest rates are higher.
If the prime rate is on the rise, look for ways to save more
Taming too-warm economic conditions
If the prime rate is trending down, get great advice
Getting a cooler economy moving again
The graph below shows the bank prime rate trend over the last 5 years (changes mirror Bank of Canada policy rate movements).
No, banks don't have to follow the policy rate automatically. Instead, banks choose to follow rate movements, usually adjusting their prime rate within a day or two of central bank decisions.
However, it's rare for banks to break with the policy rate. Past incidences of prime rate adjustment delays or varied responses (e.g. a partial adjustment) have occurred, but there have been no cases of outright ignoring policy rate guidance.
If banks ever decide not to follow a BoC rate move, it would be because the banking sector is concerned about undue financial damage.
Most bank prime rates are generally set at a spread of 2.0% above the Bank of Canada's policy rate. But that spread can deviate depending on economic conditions.
Since about 2015, the prime rate spread has been +2.20% above the BoC rate. So, a policy rate of 3.0% means bank prime rates are set at 5.20%.
Some banks may set their prime rate at a higher spread than +2.20% (e.g. at 5.25% from a policy rate of 3.0%). However, their borrowing rates for their best clients would likely still align with industry offerings, perhaps advertising a higher 'discount' off prime.
If you think you're getting a better prime-rate discount with a certain lender — make sure they're using the same prime rate as other banks (and beware, they may also make up for it with higher pre-payment penalties).
Did you know? A bank prime rate is set by the light of the central bank's policy rate, which is also referred to as these (interchangeable) terms:
Policy Interest Rate - Overnight Rate - Key Interest Rate - Benchmark Rate - Central Bank Rate – Bank of Canada (BoC) Rate
The prime rate sets the 'financial' temperature of how both fixed and variable mortgage rates fall in.
Banks can't set any mortgage rate they want — they have to manage their expenses and revenue in line with current market conditions. So, a higher bank prime rate means you'll pay a higher mortgage rate overall, no matter the rate type.
But thanks to competition for your mortgage business, you may not have to pay a mortgage rate as high as the bank's prime rate.
Mortgage lenders may offer some term rates lower than prime for stronger mortgage applications, especially those that qualify for default insurance (a high-ratio mortgage) and carry less risk.
Sometimes, that mortgage rate for a fixed-rate term can be 2.20% or lower than the posted 'prime rate,' depending on whether the lender is a big bank or a mortgage-only lender and based on the product terms and the borrower's financial details.
Variable mortgage rates are a discount directly off the bank's prime rate and can range from -1.5% to -0.5%, depending on lender competition and the economic environment.
The prime rate floats and directly influences other 'floating' interest rate products, such as variable-rate mortgages and home equity lines of credit (HELOCs).
A change in the prime rate means the same move for your variable mortgage rate.
If you have adjusting mortgage payments, your payments will go up or down depending on the prime rate change.
If you have fixed payments, your mortgage amortization will tick up or down depending on the difference in interest costs (affecting whether more or less goes toward your mortgage principal).
The prime rate doesn't lead fixed mortgage rates up and down like it does variable rates. Instead, fixed rates anticipate where the prime rate is going before it gets there.
Fixed rates are based on a different interest-rate mechanism — the bond market, specifically bond yields. Yields have similar terms (such as 2-year, 5-year, and so forth), and banks set their fixed mortgage rates at a spread of 1% to 2% to compete with bonds to attract capital.
Bond traders trade government bonds all day, every day. They have a view on where they think prime rates will go over the next 5 years, and you can see their combined opinion changing in every bond price movement.
Traders often disagree. Half believe the 5-year bond yield will trade higher, and the other half think it'll trade lower. The middle ground is where the market lands (supply and demand finding equilibrium) and is a tell for where the prime rate may be going.
So, when bond yields trend up (and fixed rates soon after that), the market expects the prime rate to rise, and vice versa.
Note: The bond market is massive, much bigger than the stock market. And like most things financial, it can get complicated. Get a simpler explanation of bond yields here.
Does one economist say rates will go higher? There's another one right behind them to say the opposite.
If you're trying to time your mortgage and rate decisions, we recommend reading up on a few opinions, not just one. The market is likely headed somewhere in the middle.
And always ask a True North broker to hold your rate, just in case.
The prime rate is used as a baseline for determining market rates for alternative and B-lending mortgages.
Sometimes referred to as subprime mortgages, these mortgages are priced above prime rates to cover heightened risk of borrower default due to credit challenges, complex terms, or non-traditional income sources.
Despite being charged higher rates, a Canadian homeowner may choose an alternative lender when a traditional bank says 'no.' These lenders are considered an essential part of the mortgage industry landscape and often help borrowers 'turn down' their financial pressures to keep their homes and eventually make their way to a better rate.
Private lenders are often considered a 'last resort' mortgage strategy if a borrower is turned down by traditional and alternative lenders, and their rates are even higher than those offered by alternative lenders.
Economic conditions influence the temperature setting of prime rates.
An overheating economy can quickly lead to higher price inflation, which can inflict significant economic damage if left unchecked by the central bank.
A hotter (higher) prime rate environment works to curb spending and growth, bring prices back in line, and restore more affordable conditions for everyday items and significant financial commitments, such as borrowing money to own a home.
Here are some of the main factors that can coax a cooler prime rate:
Our highly trained, salaried True North Mortgage brokers offer cool-headed guidance to find your best mortgage rate and product for your unique situation (in your preferred language).
Having your budget run 'hot' due to higher rates and home prices can be stressful. Our mortgage-only focus and huge volume allow us to personalize your savings through a seamless, simple process.
Continually updated. Where rates may go now and later — and what’s driving them.
See for yourself how much you can save with our lower rates.
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