The prime rate is usually referring to the interest rate that large banks charge on short-term loans to their best customers. It is used as a guideline for interest rates. The prime rate has an important role in real estate, because interest rates for a lot of loans, such as adjustable-rate mortgages and home equity lines of credit, go hand in hand with the prime rate.
What influences the prime rate?
It is mostly the economic pressures that can influence the prime rate. The prime rate is influenced by the overnight rate that is set by the Bank of Canada. The Bank of Canada’s monetary policy controls the overnight rate in a way that balances its long-term goal of avoiding inflation against short-term economic goals like reducing the unemployment rate.
In the past, the prime rate has been around 200 basis points (2%) higher than the overnight rate. When the Bank of Canada changes its target overnight rate, the big five banks typically follow. There have been occasions where the banks will not immediately change their prime rates, and some Canadian banks have different rates from their competitors. Which is why we always stress that if you chose not to go through a mortgage broker and chose to stick with a bank, make sure that you shop around and get the best rate.
How changes in the prime rate affect consumers
The way you have been handling your money has influenced your credit so everyone is affected by the prime lending rate in some way. Even if you don’t directly have a loan, chances are you are dealing with people or businesses that do.
How the prime rate influences the mortgage market in Canada
In the Canadian market of mortgages, the prime lending rate is used for calculation of lending money on the variable rate or line of credit mortgages. We have defined the two to help you gain some clarity:
A variable rate is usually a closed term, either 3 or 5 years in length. It depends on the economy and availability of mortgage money during a particular cycle, variable rate mortgages will follow prime rate minus a set discount. Although a variable rate seems like it is a clear choice, understanding your options between the different types of mortgage and loans is an important part of moneylending.
A line of credit will usually be based on prime rate plus a percentage or basis point count. A line of credit in Canada is a popular form of borrowing and all follow the prime lending rate, so there is not much difference between most institutions. Regardless of whether it’s a variable mortgage or a line of credit, they will tend to follow the prime rate of Canada. Making sure you understand the prime rate will make it easier for borrowing in the future.