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 to tame inflation, while a lower one heats them again to revive a sluggish economy.
A higher prime rate means you'll likely pay more interest on your mortgage. A lower prime rate typically means you'll pay less interest, offering improved 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, is 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 on 8 pre-scheduled dates each year when the central bank decides whether it needs 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-rate mortgage market.
A higher Canadian prime rate usually means that all Canadian interest rates are higher.
If prime is rising, look for ways to protect your budget
Amid too-warm economic conditions and rising inflation
If prime is trending down, take advantage of ways to save more
During economic recovery
The graph below shows the bank prime rate trend over the last 5 years (changes mirror Bank of Canada policy rate movements).
Typically, yes, but banks aren't mandated to follow policy rate adjustments automatically. Instead, banks choose to follow rate movements, usually adjusting their prime rate within a day or two of central bank decisions.
Banks rarely break with the policy rate. Past instances 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 particularly 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, and 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 for some products.
Do you think you're getting a better prime-rate discount with a particular lender? Check that they're using the same prime rate as other banks, and beware — they may make up for that lower prime with higher pre-payment penalties.
Did you know? The central bank's policy rate, which leads the bank prime, also goes by 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 range for fixed and variable mortgage rates, even though fixed rates are set according to bond yields (which anticipate where the prime rate may go next).
Industry competition, economic conditions, borrower details, and product type all affect how much below or above the prime rate you'll pay for your mortgage.
Lower than prime. Mortgage lenders typically offer variable mortgage term rates below prime for stronger mortgage applications, with the lowest rates going to those who qualify for default insurance (a high-ratio mortgage), since these mortgages are government-backed and therefore carry less risk to the lender.
Best-advertised variable mortgage rates are typically a discount from prime of -1.5% to -0.5%, depending on lender competition and the economic environment.
For example, if the regulatory environment is squeezing lenders for more capital, variable-rate discounts may tighten. Or, if a prime rate increase is expected, lenders may increase their discounts for a time, knowing they'll soon be compensated through a rising prime rate.
Prime or higher. Some mortgage products, such as uninsured (conventional) mortgages, open variable mortgages or HELOCs, are often offered at prime, or prime plus a premium, because of increased lender risk or operating costs. Or, if a mortgage application has lower qualifying income or credit scores, higher debt ratios, or less home equity, lenders may view it as riskier and offer higher-than-prime rates.
When a traditional lender won't accept a mortgage application within their stricter requirements, alternative and private lenders offer mortgage solutions at higher rates, called subprime rates.
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 — through the bond market.
Bond 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 and 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 shift with every bond price move.
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 signals 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 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? Usually, another one is right behind them, saying the opposite.
If you're trying to time your mortgage and rate decisions, we recommend researching a few expert opinions, not just one. The market is likely headed somewhere in the middle.
Ask a True North broker for personalized mortgage advice, and whether you should hold your rate, just in case.
Economic conditions influence the temperature setting of prime rates.
An overheating economy can quickly lead to rising prices (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, brings prices back in line, and restores more affordable conditions for everyday items and major 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).
A budget that runs 'hot' due to higher rates and home prices can be stressful. Our mortgage-only focus and high 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.
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Mystified by variable and fixed mortgage rates? Here's why they exist and what influences them.
