Prime Rate Canada: Your Guide to Smarter Borrowing

As of January 12, 2025, the bank’s prime rate in Canada is 5.45% for institutions like TD Bank, National Bank, and RBC Royal Bank. This rate was set on December 11, 2024, following the Bank of Canada’s decision to lower its policy interest rate by 50 basis points to 3.25%.

What is The Prime Rate?

The prime rate is the interest rate that banks charge their most creditworthy customers and serves as a benchmark for various variable-rate loans and lines of credit, including variable-rate mortgages. It is closely linked to Canada’s policy interest rate; when the Bank of Canada adjusts its policy interest rate, financial institutions typically follow suit by altering their prime rates accordingly.

In 2024, the Bank of Canada implemented a series of rate cuts in response to slowing economic growth and a rise in unemployment. These reductions aimed to stimulate the economy by making borrowing more affordable. The prime rate decreased from a high of 7.20% in July 2023 to the current 5.45% as a result of these policy changes.

Definition and Explanation of the Prime Rate

The prime rate is a benchmark interest rate set by financial institutions in Canada, serving as a foundation for determining the interest rates on various lending products, including variable rate mortgages, lines of credit, and other loans. This rate is closely influenced by the Bank of Canada’s policy interest rate, also known as the target for the overnight rate. Essentially, the prime rate acts as a key indicator of the overall direction of interest rates within the Canadian economy, significantly impacting borrowing costs for both individuals and businesses. When the Bank of Canada adjusts its policy interest rate, financial institutions typically follow suit by altering their prime rates, which in turn affects the rates on variable rate loans and mortgages.

Will The Prime Rate Be Lower in 2025

Looking ahead, forecasts suggest that Canada’s prime rate, which has experienced various historical fluctuations, may continue to decline in 2025, potentially falling below 5%. The current status and projected future trends indicate that this decline will be in tandem with anticipated further reductions in the Bank of Canada’s policy interest rate. This trend could have significant implications for borrowers, particularly those with variable-rate loans, as lower prime rates typically lead to reduced interest expenses.

When is the next Bank of Canada Update?

• Wednesday, January 29
• Wednesday, March 12
• Wednesday, April 16
• Wednesday, June 4
• Wednesday, July 30
• Wednesday, September 17
• Wednesday, October 29
• Wednesday, December 10

History of the Prime Rate in Canada

The prime rate in Canada has a storied history, dating back to the early 20th century. Over the decades, it has seen numerous fluctuations in response to economic conditions, inflationary pressures, and shifts in monetary policy. In recent years, the prime rate has been particularly influenced by the Bank of Canada’s policy interest rate, which is adjusted to manage inflation and foster economic growth. These adjustments are crucial as they directly impact the cost of borrowing and the overall economic activity in the country. Understanding the historical context of the prime rate helps in appreciating its role in the broader financial landscape of Canada.

Overview of the Prime Rate Changes from 2010 to 2024

The prime rate in Canada has experienced significant changes from 2010 to 2024, reflecting the dynamic nature of the economy and monetary policy. Here’s a detailed overview of the prime rate changes during this period:

• 2010: The prime rate was around 3.25%, influenced by the Bank of Canada’s policy interest rate of 1.00%.

• 2011-2012: The prime rate remained relatively stable, ranging from 3.00% to 3.25%.

• 2013-2014: The prime rate saw a slight increase, ranging from 3.25% to 3.50%.

• 2015-2016: The prime rate decreased, ranging from 2.70% to 2.90%, reflecting a more accommodative monetary policy stance.

• 2017-2018: The prime rate increased again, ranging from 3.20% to 3.95%, as the economy showed signs of strengthening.

• 2019-2020: The prime rate decreased, ranging from 3.45% to 2.45%, in response to global economic uncertainties and the onset of the COVID-19 pandemic.

• 2021-2022: The prime rate saw a significant increase, ranging from 2.45% to 6.45%, as the Bank of Canada took measures to curb rising inflation.

• 2023-2024: The prime rate decreased, ranging from 6.45% to 5.45%, as the economy adjusted to new monetary policies aimed at stabilizing growth.

Key Events and Trends in the Prime Rate History

Several key events and trends have shaped the history of the prime rate in Canada:

• The 2008 Financial Crisis: This global economic downturn led to a significant decrease in the prime rate as the Bank of Canada lowered its policy interest rate to stimulate the economy.

• Bank of Canada’s Policy Interest Rate Changes: Over the years, adjustments in the policy interest rate by the Bank of Canada have been a primary driver of changes in the prime rate.

• Impact of Inflation: Higher inflation typically leads to higher interest rates, including the prime rate, as the central bank aims to control price levels.

• Global Economic Trends: Changes in global interest rates and economic conditions have also influenced the prime rate in Canada, reflecting the interconnected nature of modern economies.

Understanding these events and trends is crucial for individuals and businesses as they navigate borrowing and investment decisions. The prime rate, influenced by a myriad of factors, remains a pivotal element in the financial ecosystem of Canada.

How is The Prime Rate Calculated?

The prime rate is influenced by Canada’s overnight rate, which is set by the Bank of Canada. Financial institutions determine the prime rate based on changes in the Bank of Canada’s overnight rate, which impacts the interest rates on various lending products like mortgages and lines of credit. Here’s how the process works:

Policy Interest Rate

• The Bank of Canada sets a policy interest rate (also called the overnight rate) as part of its monetary policy to manage inflation and economic growth.

• This rate influences the cost of borrowing between banks for short-term loans.

Prime Rate Determination

Banks set their prime rate based on the policy interest rate.

Various financial institutions, including banks and credit unions, set their respective prime rates based on the influence of the Bank of Canada’s overnight rate. The prime rate typically exceeds the policy rate by a consistent margin, often around 2-3%, to cover bank operational costs and risks.

For example:

• If the Bank of Canada’s policy rate is 3.25%, banks might set their prime rate at 5.45% (policy rate + margin).

Adjustments by Banks

• When the Bank of Canada changes the policy rate, banks usually adjust their prime rate within a few days.

• Each bank can technically set its own prime rate, but in practice, most large Canadian banks maintain the same prime rate to remain competitive.

Factors Affecting the Prime Rate

While primarily tied to the central bank’s policy rate, banks may also consider:

• Economic conditions: Inflation, unemployment, and GDP growth.

• Market competition: How other banks set their rates.

• Risk and costs: Credit risks and operational expenses.

In essence, the prime rate reflects the cost of funds for banks, plus a markup for profitability, and serves as the benchmark for various loans like variable-rate mortgages, lines of credit, and business loans. When the Bank of Canada raises the overnight rate, it becomes more expensive for banks to borrow money, leading to higher prime rates, which in turn impacts the cost for individuals to borrow money through various lending products.

How is The Overnight Rate Calculated?

The overnight rate is calculated and managed by the central bank, such as the Bank of Canada, to maintain control over monetary policy. Here’s how it works:

Definition of the Overnight Rate

The overnight rate is the interest rate at which major financial institutions borrow and lend funds to one another for short-term (typically one day) transactions. It serves as the foundation for other interest rates in the economy, including the prime rate.

Calculation and Setting by the Bank of Canada

The Bank of Canada does not calculate the rate per se but instead sets a target for the overnight rate as part of its monetary policy framework. The process includes:

Monetary Policy Decision

The central bank reviews economic indicators, such as:

• Inflation rates

• Employment levels

• Economic growth

• Global economic trends

It determines Canada’s policy interest rate needed to achieve its goals, such as keeping inflation within a target range (usually 1-3%). The Bank of Canada sets this rate as a benchmark for overnight loans between financial institutions, influencing the prime rate set by major Canadian banks and affecting borrowing and lending costs in the financial market.

Operating Band

• The Bank of Canada establishes an operating band for the overnight rate, typically 0.5% wide.

  • Upper limit: The rate at which the Bank lends to financial institutions.

  • Lower limit: The rate it pays on deposits held at the Bank.

• The midpoint of this band is the target overnight rate.

Market Intervention

• To ensure that the actual overnight rate remains close to the target, the Bank conducts daily market operations:

  • Lending or borrowing to manage liquidity.

  • Using tools like open market operations or repo agreements (where the Bank buys or sells securities to inject or withdraw cash from the banking system).

Influences on the Overnight Rate

The actual overnight rate is influenced by:

• Supply and demand for funds among financial institutions.

• Liquidity needs of the banking system.

• Market expectations regarding future central bank actions.

Relationship to Broader Economy

The overnight rate indirectly influences other interest rates, such as:

• Mortgage rates

• Business loan rates

• Savings and deposit rates

This cascading effect allows the central bank to control the economy by encouraging or discouraging borrowing and spending. Changes in the overnight rate can lead to lower borrowing costs, which in turn can stimulate economic activity by making it cheaper for consumers to take out mortgages and for businesses to secure loans.

Example:

If the Bank of Canada’s target overnight rate is 3.25%:

• Banks lending to each other overnight will aim for that rate.

• If actual rates deviate, the Bank intervenes to bring them back to target.

In this way, the overnight rate serves as a critical tool for maintaining economic stability and achieving monetary policy objectives.

How Does The Prime Rate Impact Mortgage Rates?

The prime lending rate, an interest rate set by major Canadian financial institutions and influenced by the Bank of Canada’s policy interest rate, has a significant impact on mortgage rates, particularly variable-rate mortgages and home equity lines of credit (HELOCs). Here’s a breakdown of how the prime rate influences mortgage rates and the overall cost of borrowing for homeowners:

Direct Link to Variable-Rate Mortgages

• Variable-rate mortgages are directly tied to the prime rate.

• Lenders offer variable-rate mortgages at the prime rate plus or minus a specific percentage (e.g., “Prime – 0.5%”). These are known as variable interest rates, which are determined by the prime rate set by institutions. Various factors, including creditworthiness, influence the final rate a borrower might receive for loans and mortgages.

• For example, if the prime rate is 5.45%, and the lender offers “Prime – 0.5%,” the mortgage interest rate would be 4.95%.

• When the prime rate changes (due to changes in the central bank’s policy rate), the interest rate on a variable-rate mortgage adjusts accordingly:

• Prime rate increases → Higher mortgage payments.

• Prime rate decreases → Lower mortgage payments.

Indirect Influence on Fixed-Rate Mortgages

While fixed-rate mortgages are not directly tied to the prime rate, they are influenced by factors that affect the prime rate:

• Fixed mortgage rates are more closely linked to bond yields (e.g., 5-year Government of Canada bonds).

• Bond yields tend to rise or fall based on:

  • Inflation expectations.

  • Central bank monetary policy (which also impacts the prime rate).

• When the prime rate increases due to rising policy rates, bond yields often follow, leading to higher fixed mortgage rates.

Effect on HELOCs

• HELOCs are directly tied to the prime rate and fluctuate with it.

• As the prime rate increases, interest costs for HELOCs also rise, making borrowing more expensive.

Borrowing Costs and Affordability

Changes in the prime rate affect mortgage affordability:

• Rising prime rates:

  • Increase monthly payments for variable-rate mortgages and HELOCs.

  • Reduce affordability for new borrowers, as higher interest costs reduce the amount they can qualify for.

• Falling prime rates:

  • Lower monthly payments for variable-rate products.

  • Encourage borrowing and home purchases due to reduced costs.

The Impact of The Prime Rate on Mortgage Renewals

The prime rate significantly impacts mortgage renewals, especially for homeowners with variable-rate or adjustable-rate mortgages. The prime rate is the benchmark interest rate set by banks, influenced by the central bank’s monetary policy. It affects how much interest lenders charge borrowers.

When the prime rate rises, it often leads to higher interest rates on new mortgages and mortgage renewals. This means that when your mortgage term ends and you renew, you could face higher monthly payments due to increased interest costs. Conversely, if the prime rate drops, renewing homeowners may secure lower rates, reducing their payments.

For those with fixed-rate mortgages, the effect is indirect but still relevant. While the prime rate doesn’t directly change their current payments, it influences the rates available at renewal. Preparing for potential rate changes is essential to avoid financial strain when it’s time to renew your mortgage.

Impact on Decision-Making

Homebuyers and homeowners must weigh their options based on the prime rate:

• Variable-rate mortgages:

  • Offer lower initial rates but are riskier if the prime rate rises.

• Fixed-rate mortgages:

  • Provide stability but can be costlier if the prime rate and bond yields decline.

Example:

• Suppose you have a $400,000 variable-rate mortgage at “Prime – 0.5%” and the prime rate is 5.45%:

  • Initial interest rate = 4.95%.

  • If the prime rate increases by 1%, your interest rate becomes 5.95%.

  • This could add hundreds of dollars to your monthly payments.

In summary, the prime rate plays a pivotal role in determining the cost of variable-rate mortgages and HELOCs and indirectly influences fixed-rate mortgages through broader economic trends. Homebuyers and borrowers need to monitor changes in the prime rate to make informed decisions about their mortgage strategies.