Over the last few years, as rising interest rates and inflation commanded so much of our attention, it suddenly seemed nearly impossible to even go a day without hearing the news or a friend talking about Canada’s “prime rate.” Yet for many Canadians, aside from having a faint sense that the prime rate has something to do with interest rates, the meaning of the term remains a mystery. So what exactly does prime rate mean and how can it have such a potentially powerful impact on your life?
In this article, we’ll explore what the prime rate is, how it’s determined and how it affects borrowing costs. We’ll also look at its potential implications for your financial life. Whether you’re a homeowner with a variable-rate mortgage or simply want to better comprehend how interest rates work, understanding the prime rate will help you make more informed financial decisions.
What Is The Prime Rate In Canada?
The prime rate in Canada, also known as the prime lending rate, is the key interest rate that financial institutions use to set the interest rates for lending products like variable-rate mortgages, lines of credit and personal loans.
Often, to be competitive, financial companies like the Big Six banks in Canada will all have comparable prime rates. Whether or not you’ll get the prime rate for your loan product will depend on your creditworthiness and factors such as your credit score and financial health. If you have a less-than-ideal credit history, the rate the lender offers you may be slightly higher than the prime lending rate.
Note: If you have a variable-rate product like a line of credit or variable-rate mortgage, your interest owing will change as your bank’s prime rate rises or decreases.
Learn More: How To Choose Between Canada’s Five Major Banks?
Current Prime Rate In Canada As of December 2024, the prime rate in Canada stands at 5.95% (the Bank of Canada’s policy rate is 3.25%). Note that banks’ prime rates tend to be higher (approx 2% higher give or take) than the Bank of Canada’s policy interest rate. |
How Is The Prime Rate Set In Canada?
How does a bank set its prime rate and why do banks sometimes lower or increase this rate?
Most major financial institutions in Canada base their prime lending rate on the Bank of Canada’s (the country’s central bank) policy interest rate, also called the overnight rate. This is the rate the Bank of Canada sets as the benchmark interest rate at which financial institutions lend money to each other overnight. If the Bank of Canada raises or lowers its overnight rate, then Canada’s lending institutions raise or lower their rates correspondingly.
Why Does The Bank Of Canada Change Its Policy Interest Rate (Overnight Rate)?
Because banks’ prime rates are so dependent on the Bank of Canada’s policy rate, it’s helpful to understand why the nation’s central bank would change its rate. While rate changes come about due to a variety of very complex economic and political factors, in simple terms, the primary reason that the Bank of Canada alters its rate is to control inflation and help maintain the health of the Canadian economy.
The Bank aims to keep Canada’s inflation rate to no more than 2% because, at this level, prices tend to be more stable, which in turn helps the economy run more smoothly. When inflation rises too high—often due to increased consumer demand or supply chain problems—the Bank raises its policy rate to slow down spending and make borrowing more expensive. This helps cool off rising inflation. Conversely, when inflation is too low or the economy is too stagnant, the Bank lowers its policy rate to encourage borrowing and stimulate economic activity.
Learn more: The 3 Main Factors Influencing The Bank of Canada’s Interest Rates
What Is The Difference Between The Prime Rate, Policy Rate And Interest Rate?
While these terms are all related, they have different meanings that are important to keep straight to better understand Canada’s financial system:
- Prime rate: The prime rate is the benchmark interest rate that most financial institutions in Canada use for lending products like mortgages or lines of credit. Each bank determines its own prime rate but it is heavily influenced by the Bank of Canada’s policy rate.
- Policy rate: The policy interest rate (also known as the overnight rate) is the rate set by Canada’s central bank, the Bank of Canada, for overnight lending between financial institutions across the country. The Bank determines its rate based on key economic indicators like inflation and the health of the country’s economy. Usually, when the Bank of Canada raises or decreases its policy rate, Canada’s banks will soon follow with a similar increase or decrease.
- Interest rate: This is a broader term that refers to the cost of borrowing money or the interest you’ll get on savings products like savings accounts and GICs. Interest rates can be fixed or variable. While interest rates on loans are often based on the prime rate (e.g., “prime + 1%”), they may also be influenced by other factors like creditworthiness, the loan type and various market conditions.
Importance Of Keeping Track Of The Prime Rate For Canadians
The Bank of Canada’s policy rate is of key importance to Canadians. If it rises, then your bank’s prime rate will also likely rise, which means that the interest rates you’re charged on variable-rate mortgages and loans will also increase. On the bright side, if the bank increases its prime rate, interest rates on your savings account and other financial instruments like GICs, will also likely rise.
By understanding how the prime rate works, you can make better decisions when it comes to borrowing and saving money.
Where Can I Keep Tabs On The Prime Rate?
There are several ways you can keep up to date on changes in Canada’s prime rate:
- Check out the Bank of Canada’s website; it has updates on overnight rates and other financial information.
- Check major Canadian banks’ websites for their current prime rates or contact your bank or lender directly to inquire.
How Does The Prime Rate Affect Borrowing Costs
How the prime rate in Canada will affect your borrowing will depend on the type of financial product you have:
Variable Rate Loans
Though you may not readily think of them as such, any loan with an interest rate that can change over the course of your loan — such as variable rate mortgages, home equity lines of credit (HELOC) and unsecured lines of credit — are variable rate loans. Interest rates for these types of loans are based on your lender’s prime rate.
When the prime rate increases (usually because the Bank of Canada increases its policy rate), so does the interest rate on these loans, which can lead to higher monthly payments or more of your monthly payments will go toward the interest than the principal. Conversely, when the prime rate decreases, borrowers with variable-rate loans enjoy a decrease in their interest rates.
Learn more: How Will The Bank Of Canada’s Interest Rate Cut Affect You?
Credit Cards
In Canada, credit cards for the most part come with a fixed rate of interest, usually between 19.99% to 23.99%. However, there are a few specialized credit cards that use variable rates tied to the prime rate. For example, the TD Emerald Flex Rate Visa Card offers a variable interest rate based on TD’s prime rate plus an additional percentage, ranging from 4.50% to 12.75% and RBC has a RateAdvantage Visa with a purchase rate of Prime + 4.99% to 8.99%.
How Does The Prime Rate Affect Your Saving Accounts?
While savings account interest rates are not directly tied to the prime rate like lending rates are, they are nonetheless influenced by the Bank of Canada’s policy interest rate. As previously discussed, when the Bank of Canada raises its policy rate, banks typically follow suit by increasing their prime rate. Since banks are making more money off of loans, they can afford to offer higher interest rates on savings accounts and other savings products like GICs.
Conversely, when the Bank of Canada lowers its policy rate, banks reduce their prime rate, which often leads to lower savings account interest rates. That’s why when prime rates go up, interest rates on your savings accounts go up and vice versa.
How Often Does The Prime Rate Change?
The prime rate in Canada typically changes whenever the Bank of Canada changes its policy interest rate. But the Bank of Canada can’t change its policy rate willy-nilly. Rather, there are only eight fixed dates a year during which it may raise, lower or maintain its overnight rate. Whether or not the Bank of Canada will change its rate is based on economic conditions, such as inflation and overall economic growth. As of Dec 1, the Bank of Canada has changed its rate four times in 2024.
Will The Prime Rate Increase In 2025?
Financial experts and stock market investors would love to have a crystal ball to predict the future, but the reality is no one really knows for certain what will happen to the prime rate in 2025 because the direction of the prime rate depends on numerous complex economic factors.
That being said, as of late 2024, many financial experts appear to think that the prime rate is more likely to decrease than increase in 2025. This forecast is based on the Bank of Canada’s recent trend to decrease its policy interest rate as inflation and economic growth cool. Of course, if inflation suddenly takes off again or the economy strengthens, the Bank of Canada could decide to raise their policy rate. It’s impossible to know with 100% certainty what will happen to the prime rate in Canada because the economy is always in flux.
Learn more: Canadian Mortgage Rate History
Bottom Line
By understanding prime rates in Canada, you’ll have a better, more comprehensive understanding of how banks and the Bank of Canada determine interest rates — and how those rates are in turn determined by the health of the country’s economy. When the Bank of Canada raises its policy rate to curb inflation, banks typically increase their prime rate. On the other hand, when the Bank of Canada lowers its policy rate to stimulate the economy, banks reduce their prime rate, which makes borrowing more affordable.