The Canadian housing market is always changing, so it’s important to understand key financial terms – especially if you have a mortgage or want to buy a home. One of these key terms is the Prime Rate, which affects how much you pay on your mortgage each month. Let’s break down how the prime rate works and why it matters.
What is the Prime Rate?
The Prime Rate is the interest rate that banks in Canada charge their best customers (those with good credit). It’s like a benchmark that influences the interest rates on different loans, especially variable-rate mortgages and home equity lines of credit (HELOCs). The Prime Rate itself is heavily influenced by the Bank of Canada’s Overnight Rate, which is the interest rate at which banks lend and borrow money from each other overnight. When the overnight rate changes, the Prime Rate usually follows.
How Does the Prime Rate Affect My Mortgage?
With variable-rate mortgages, there are two types:
- True Variable Rate: In this scenario, your payment remains ‘static’, even as the Prime Rate fluctuates. However, the portion allocated to interest versus principal changes. When rates decline, a larger portion of your payment goes toward the principal, accelerating your mortgage payoff. Conversely, rising rates mean more of your payment covers interest, extending the amortization period.
- Adjustable Rate Mortgage: Often mistaken for a variable rate, an adjustable-rate mortgage actually “adjusts” with every Prime Rate change, causing payment fluctuations. This can be challenging for budgeting during rising rate periods but offers cash flow savings as rates decline.
- Fixed-Rate Mortgage: Fixed-Rate Mortgage: Determined by bond yields, the Prime Rate does not affect fixed-rate mortgage payments. Therefore, if you have a fixed-rate mortgage, the buzz around Prime Rate drops doesn’t impact you. Even with a pre-approval for a fixed rate, you wouldn’t see much change or savings as fixed rates are currently lower than variable/adjustable rates…
However, Change in Prime can indirectly impact fixed rates over time. Simply put: When the Bank of Canada lowers the prime rate, it signals a more cautious economic outlook or a need to stimulate growth. This often leads investors to buy bonds as a safe haven, driving bond prices up and yields down. As bond yields drop, lenders typically reduce fixed mortgage rates because their own cost of funds is lower.
Why Should I Care About the Prime Rate?
- Impact on Monthly Payments: Changes in the Prime Rate directly impact your monthly payments if you have a variable-rate mortgage. A significant increase in the Prime Rate can lead to ‘payment shock,’ where your payments rise substantially. Fortunately, that’s not expected to happen for a few years, as the Prime Rate is projected to keep dropping until it plateaus in 2026.
- Financial Planning: The Prime Rate is a good indicator of how the economy is doing. Understanding how it changes can help you plan your finances better, especially when it comes to renewing your mortgage or borrowing money.
What Should I Do Next?
Prime Rate recently dropped, which could affect your finances. It’s a good idea to talk to a mortgage professional about your options. They can help you figure out:
- If your current mortgage is still the best choice for you
- If refinancing to a different mortgage would be a good idea
- How future changes in the Prime Rate might affect your monthly payments and financial goals
Don’t try to figure out the complicated mortgage world on your own. The mortgage professional we work with can help you make smart choices and get the most out of your mortgage.
Book a time to talk to Lisa! www.chatwithlisareynolds.ca
