Economic policy makers determine the interest rate which banks charge each other to lend money. However, not many Canadians are aware of this information and how it trickles down to their finances. Although, the Canadian prime rate has an affect on the interest rate you pay on financial products too. So what is the Canadian prime rate and how does it affect you?
Let’s look at a quick example to demonstrate why the Canadian prime rate is important. Say you took out a 5-year loan of $100,000 at a variable interest rate of 3.45% (2.45% prime rate + 1%). Your monthly payment would be $1,772.53. A few months later, the prime rate increases to 6.7%, so your new interest rate is 7.7%. Your monthly payment would increase to $2,013.31 — about a $250 increase which is substantial!
You won’t know all this information if you are unaware of the current rates and how changes can impact your finances. Sound knowledge of interest rates will help you know what to expect from your loans and other financial products.
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If you are a newbie, no need to worry! We’ll guide you on the concept of the Canadian prime rate. By the end of this article, you’ll understand how it affects your banking and finances and its predictions for the future. Ready, let’s get started!
What is a Prime Rate?
A prime rate is a baseline interest rate set and used by banks and financial institutions. It is the interest rate charged by one bank to borrow from another bank. In other words, it’s the cost of lending between financial institutions. Individuals with exceptional credit can often borrow from banks at the prime rate as well. In addition, the prime rate is used as a base for variable interest rate products.
What is a Overnight Rate?
The overnight rate is the interest rate set by the Bank of Canada, or other central banks. In the United States, the equivalent body is the Federal Reserve, or “the Fed” for short, as a comparable. The overnight rate is the interest rate which banks charge each other to lend money. Sound familiar? The prime rate and overnight rate are virtually the same, but they’re set and managed by two different entities.
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How do prime rates work?
Banks come up with their own prime rate by closely monitoring the Bank of Canada’s overnight interest rate. In many instances, they are same number, but in some cases they may be different. Commercial banks use overnight rates to borrow money amongst themselves from the surplus in their reserve. Furthermore, this doesn’t mean the overnight rate and prime rate are the same. It just means that one influences the other. At the end of the day, each entity sets their internal rate based on their circumstances.
You may wonder if all the banks or financial institutions use the same prime rate. Each bank and financial institution is given the authority to set their own prime rate, so there’s no obligation for it to be uniform. Although, the prime rate is often similar across all institutions, especially the big five banks. But the rate may vary with alternative banks and financial institutions.
So what’s the implication? The implication is there is a “set” prime rate at every point in time. Banks routinely update their prime rates and people and businesses respond accordingly.
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What is the Canadian Prime Rate Today?
The Canadian prime rate as of today, March 13th, 2023, is 6.7%. You can check the news daily for current prime rates and changes to the rate.
History has it that the highest ever prime rate in Canada was 20%. This happened in 1981 due to the global oil crisis. After that, the rates began to stabilize. In the pre-pandemic years of 2018 to 2019, rates dropped to 3.95%. When Covid-19 came along, the economy was greatly affected and rates dropped to 2.95% — a shocking, sometimes even surprising, low. As the economy rebounds from the international pandemic, we’re seeing a steady rise in the prime rate which has put financial strain on borrowers.
Let’s briefly look at the history of prime rates in Canada from the last 10 years.
| Effective Date | Prime Rate | Change |
|---|---|---|
| January 25, 2023 | 6.70% | 6.70% |
| December 8, 2022 | 6.45% | 0.50% |
| October 27, 2022 | 5.95% | 0.50% |
| September 8, 2022 | 5.45% | 0.75% |
| July 14, 2022 | 4.70% | 1.00% |
| June 2, 2022 | 3.70% | 0.50% |
| April 14, 2022 | 3.20% | 0.50% |
| March 30, 2020 | 2.45% | -0.50% |
| March 17, 2020 | 2.95% | -0.50% |
| March 5, 2020 | 3.45% | -0.50% |
| March 3, 2020 | 2.70% | 0.25% |
| October 25, 2018 | 3.95% | 0.25% |
| July 12, 2018 | 3.70% | 0.25% |
| January 18, 2018 | 3.45% | 0.25% |
| September 7, 2017 | 3.20% | 0.25% |
| July 13, 2017 | 2.95% | 0.25% |
| July 16, 2015 | 2.70% | -0.15% |
| January 28, 2015 | 2.85% | -0.15% |
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Will Interest Rates Go Down in 2023 in Canada?
Reports from a market survey showed that inflation rates will decline toward the end of 2023. This survey involved insurance firms, financial planning companies, mutual funds managers, and institutions alike. This reduction in inflation may bring the current prime rate of 6.7% down to 4%, all things being equal. When prime rates decrease, the rate borrowers pay will also decrease.
Inflation and prime rates are correlated. Usually when inflation is high, like it is now, central banks attempt to slow it by increasing the cost to borrow. The idea is that people will spend less, which slows economic activity, which then brings down inflation.
To answer the question, interest rates may go down in 2023 in Canada as inflation cools. Many Canadians will welcome this considering recent interest rate hikes. However, this is simply a prediction — no one can say for sure what will happen! And given the economic volatility in recent years, it’s hard to know for sure. But to help you better understand, let’s look at some factors that may lead to a change in the interest rates:
1. Banks and their assets
The growth or depreciation of a bank’s assets will greatly affect its interest rates. If banks have more assets or they’re appreciating, they would fix moderate or low-interest rates. If their assets are low or highly depreciated, they may increase their interest rates to make up for their losses.
2. Global rates
The global exchange rates may reduce or increase interest rates. If the Canadian Dollar is performing poorly, for instance, interest rates may skyrocket. If the currency is doing great, interest rates will drop. In addition, the global economy is interconnected. When other countries increase their prime rates, chances are the same will happen in Canada. As an example, the United States is experiencing interest rate hikes right now, just like Canada.
3. Other economic factors
As mentioned above, inflation and the prime rate are correlated. This is simply one economic factor, but others can impact the prime rate too. For instance, the demand for loans, the unemployment rate, and much more.
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Will Mortgage Rates Go Down in 2023?
The same applies here as with above. If the prime rate decreases, as it’s expected to with inflation, then mortgage rates could go down by the end of 2023 as well. Keep in mind that prime rate changes only impact your mortgage payment if you have a variable rate mortgage. If you have a fixed rate mortgage, you won’t have to worry about fluctuations in the prime rate!
What are the Current Prime Rates in Canada?
Below are the current prime rates for major banks in Canada. These numbers are accurate as of March 13, 2023.
| Financial Institution | Prime Rate |
|---|---|
| Scotiabank | 6.7% |
| BMO | 6.7% |
| RBC | 6.7% |
| TD | 6.7% |
| National Bank | 6.7% |
| CIBC | 6.7% |
As you can see, the prime rates for each bank are all equivalent. Currently, the Bank of Canada’s overnight rate is set at 4.5% for reference.
How Do Prime Rates Affect Canadians?
Changes to the prime rate mainly impact variable rate financial products. If you have a fixed rate financial product, such as a credit card or fixed rate mortgage, an increase or decrease in the prime rate won’t impact you. This is because you’ve agreed to pay a certain rate on the product so banks don’t have the authority to change after the fact.
On the other hand, variable rate financial products usually express the interest rate as prime plus a certain percentage. For example, you might have a variable interest rate on your home equity line of credit. If the prime rate increases, the interest you pay on your line of credit will increase too. This can pose financial challenges because you might be stuck paying more on your borrowed funds unexpectedly. In fact, many Canadians are experiencing this now since the prime rate nearly doubled in under a year.
As a general rule of thumb, it’s best to use fixed interest rates when the economy is in a volatile state. But it’s best to use variable interest rates when the economy is unstable. Having an understanding of basic economic principles and the current state of the Canadian economy can help you choose between fixed and variable interest rates. However, some foresight is needed to be effective. If you try to refinance when interest rate hikes are occurring, you may be out of luck. Often, banks limit refinancing when markets are volatile because it’s not in their personal interest to do so.
Not sure how to navigate prime rates? Reach out to a financial advisor for help today!
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