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Prime Lending Rate or “Prime Rate” in Canada
What is the Prime Rate?
In Canada, the prime rate is a guideline interest rate used by banks on loans for their most creditworthy, best, or "prime" clients. The prime rate rises and falls with the ebb and flow of the Canadian economy, influenced significantly by the overnight rate, which is set by the Bank of Canada.
The prime rate is of particular significance to variable rate mortgages, which are mortgages that use a rate that tracks the prime and changes in lock-step with it over the term of the mortgage. It's only natural that because of this, variable rate mortgages are less insulated from economic fluctuations than their fixed-rate mortgage counterparts.
The Prime Rate & Variable Rate Loans
The prime rate itself is not often applied directly to variable rate loans themselves. Instead, these loans are set to track the prime rate with an adjustment value added to or subtracted from the prime rate. When the adjustment value subtracts from the prime rate, this constitutes what is otherwise known as sub-prime lending.
For example, when prime lending rates were high, many Canadian lenders were offering variable rate mortgages as low as prime minus 0.90 per cent. Since then, economic pressures and shrinking profit margins have forced banks and lenders to decrease prime rate adjustments to anywhere between prime minus 0.21 to prime plus 0.20 per cent.
Current Prime Interest Rate:3.20%
What influences the prime rate?
The prime rate is influenced primarily by the key overnight rate, which is set by the Bank of Canada on only eight pre-announced days per year. The overnight rate is in turn set in response to certain economic pressures.
The Bank of Canada's monetary policy manipulates 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.
Historically, the prime rate has been somewhere around 200 basis points (2%) higher than the target overnight rate. When the Bank of Canada increases or decreases its target overnight rate, the big five banks typically follow suit. However, there have been occasions where the banks don't immediately change their prime rates, and some Canadian banks have had different prime rates from others.
How changes in the prime rate affect consumers
Businesses, families, and individuals alike cannot avoid credit products, all of which are affected by either the prime rate, or at a deeper level, overnight rates.
Even without having a loan yourself, it's highly likely that you're dealing with a business or person that does. Perhaps you have a credit card. Maybe you buy your fuel at a gas bar that hasn't paid off their commercial mortgage yet. Perhaps the company you work for has a line of credit. Maybe the guys behind the website you're currently visiting have an emergency line of credit. (Wait, what? We didn't just say that.)
One way or another, the effects of changes in these interest rates manifest themselves in your day-to-day life. A higher prime rate might cause that gas bar you visit to charge a few cents more on the litre. It's a pretty safe bet that somewhere along the line, someone who was responsible for making a component for the computer you're currently using manufactured their part on borrowed funds, and that increased the cost of your computer.
How the prime lending rate influences the mortgage market in Canada
In the Canadian mortgage market, the prime rate is used for calculating and lending money on variable rate or line of credit mortgages.
A variable rate is typically a closed term, either 3 or 5 years in length. Usually, depending on the economy and availability of mortgage money during a particular cycle, variable rate mortgages will follow prime rate less a set discount. For example: Some variable rates will have a Prime Rate minus 0.5%. Today, the prime rate is set at 3.20% and the best variable rate is 2.20%
A line of credit will typically be based on prime rate plus a percentage or basis point count. A line of credit in Canada is a very popular form of borrowing and regardless of the lender you deal with, they all follow the prime rate lending model so there is very little variance from institution to institution. Regardless of whether it's a variable mortgage or a line of credit, they are both heavily based on and follow the prime rate in Canada. When the prime rate changes, so too can the variable rate or line of credit interest calculation that is used for your loan. Making sure you understand the prime rate and how it is tied to our monetary system and the Canadian economy will make things easier when it comes to deciding what options you choose when borrowing money.
Prime Rate History in Canada
Prime Rate Historical Graph
Notable Prime Lending Rate Observations since 1975
Average Prime Rate in Canada from January 1975 to present: 7.62%
Highest Prime Rate observed: 22.75% on Wednesday, August 12th 1981.
Lowest Prime Rate observed: 2.25% on Wednesday, April 22nd 2009.