This past June, inflation hit its highest peak since 1983, and it’s impossible to ignore its impact on the everyday lives of Canadians.
The word “inflation” refers to a general increase in prices, but it doesn’t just affect the cost of everyday expenses, like gas and groceries. In fact, inflation can quickly snowball into rising interest rates which impact the loans we carry. It all stems from the Bank of Canada and its influence on the prime rate in Canada. Whether you currently carry a loan, are on the lookout for a home, or are curious about the impact of rising interest rates, let’s talk about how the prime rate in Canada affects loans.1
What’s the prime rate in Canada?
The prime rate in Canada is the annual interest rate that financial institutions across the country use to set interest rates for variable rate loans and lines of credit. It’s basically the middle-ground between Canada’s central bank rate and the rate your financial institution will offer for your loan. The current prime rate in Canada (as of October 2022) is 5.45%.
Where does the prime rate come from?
It doesn’t just appear from thin air; the prime rate in Canada is influenced by the Bank of Canada, which uses its own policy interest rate to steer our economic ship and combat inflation. In times of high inflation, the Bank of Canada will raise interest rates in an effort to reduce how much Canadians spend and the amount of personal debt we take on.
Here’s a quick overview of the differences between the Bank of Canada’s interest rate, the prime rate in Canada, and the variable interest rate you’re offered on a loan.
- Policy interest rate (or ‘overnight rate’): the tool used by the Bank of Canada to control inflation. This is basically the starting point for setting interest rates across Canada.
- Prime rate: the base interest rate that a financial institution will lend money for in order to cover the policy interest rate and their own operating costs. This is basically the middle-ground between Canada’s central bank rate and the rate your financial institution will offer for your loan.
- Your variable interest rate: the rate you’re offered for your loan. While influenced by the prime rate, it’s usually higher — depending on your lender, demand for and supply of money, and other economic factors.
Whenever the Bank of Canada changes its policy interest rate, it’s more expensive for banks to borrow money, so financial institutions will typically raise their own prime rates within a few days to cover costs.
If you’re in a season of saving money, this can be good news — a possibility for higher returns on savings accounts and guaranteed investment certificates (GICs). But it can also increase costs for borrowers, specifically those with variable loans and lines of credit.
How the rising prime rate in Canada affects your loans.
If you have an existing loan or line of credit with a fixed rate – whether it’s a student loan, fixed rate mortgage, or savings account – it won’t be affected by a change in the prime rate until it’s time for renewal. But if you carry any variable rate loans, it’s time to connect with your lender.
Even if payments on your variable rate loan have stayed the same throughout this high interest period, more of your money will be going toward interest (the amount you owe to the lender) and less toward the principal (the amount you borrowed for your purchase).
On top of that, if your interest rate level hits what’s known as a ‘trigger rate’, you may have to increase your payments or reassess your payment setup. Learn more about trigger rates and variable rate mortgages in our recent blog post, which covers 5 things to know as interest rates climb.
Keep in mind that variable rate loans aren’t limited to just mortgages. An increase to the prime rate can also impact small business loans, lines of credit (LOCs), car loans, personal loans, home equity loans and credit card interest rates.
No matter the loans you carry, check out our blog post for 4 ways to protect yourself when interest rates rise and contact your lender with any questions or concerns you may have.
Have a variable rate loan? Here are your next steps.
At Vancity, we want you to understand all of your options and feel supported and empowered in choosing the one that’s best for you.
Especially if you have a variable rate loan, ask yourself how your current payment setup is working for you. What’s more important to you – rate, payment, amortization, or flexibility? What has changed in your life since you first took out this loan? Are you hoping to maintain the same or a similar payment amount in future?
Just because you carry a variable rate loan doesn’t necessarily mean your payments will increase during this time of rising interest rates, but it’s an excellent moment to get clear on the type of loans you carry and make decisions to help ensure you feel as comfortable as possible with your financial picture.
Now that you know more about how the prime rate in Canada affects your loans, connect with us to talk about your options. To help reduce the impact of rising interest rates on your loan, you may consider one or a combination of the options mentioned below, depending on the type of loan you carry.
- Increasing your payments to maintain your current amortization or loan term
- Modifying your loan into a fixed term
- Making a lumpsum payment to lower your loan
If you carry a variable rate loan and haven’t yet assessed your options for changing your payment setup, connect with a Vancity Account Manager or Renewal Centre Specialist for support with personal borrowing or to discuss your business’ mortgage. They’ll be glad to guide you through this process and determine a path forward that matches your financial goals.
1The information provided in this post is based on Vancity products.