Mortgage Basics - How the Bank of Canada Affects Banking Rates
Tuesday May 12th, 2020Share
How Banks Make Money?
Banks borrow money at a slightly higher rate than the rate posted by the Bank of Canada. They in turn, lend money for a higher interest rate via mortgages and loans. The difference between the interest rate at which the bank borrows money and the amount they receive via client mortgage payments is profit.
Bank of Canada Key lending "interest" rate (aka bank rate, overnight rate): is the interest rate at which major financial institutions borrow and lend one-day (or "overnight") funds among themselves; the Bank sets a target level for that rate. 'The Bank of Canada steers the overnight rates banks charge each other. It pays out interest at a rate that’s 25 basis points below the key rate to banks that deposit money with it overnight and charges interest at a rate 25 basis points above it."1 Therefore, if the Canada Key Lending rate is .25%, banks borrow money at the rate of .50%
Banks set the prime rate in response to the Bank of Canada key lending rate. Each bank sets its own prime rate, but the big five banks usually all have the same prime rate.2
The prime rate, also known as the prime lending rate, is the annual interest rate Canada’s major banks and financial institutions use to set interest rates for variable loans and lines of credit, including variable-rate mortgages.2
How Banks Set Interest Rates?
- When the Bank of Canada raises the overnight rate, it becomes more expensive for banks to borrow money, and they raise their respective prime rates to cover the added costs.
- Conversely when the Bank of Canada lowers the overnight rate, banks usually lower their prime rates by the same amount.2
Variable Rates vs Fixed Rates
Variable Rate Mortgages as well as home equity lines of credit are closely linked with the Bank of Canada’s key interest rate. Therefore, when the Bank of Canada raises or lowers the key lending rate the interest rate offered by banks for variable mortgages will follow suit; raising or lowering accordingly.
- Variable rate mortgages are generally expressed as prime rate plus or minus a certain percentage.
Ex: If the prime rate is 2.45%
A 1-year variable rate mortgage may be offered at:
2.45% prime +0.00
3.2% prime +.75
3.65% prime + 1.2
- The interest rate on a variable mortgage is lower than a fixed rate mortgage due to the added risk of volatility; the rate could go up or down during your term adding to your monthly payments.
- Make sure you can handle the stress of knowing the interest rates can change. If you cannot deal with the stress, choose a fixed rate mortgage.
- However, most lenders will allow you to lock into a fixed rate mortgage during your term if the rates start to rise. This should be in your contract.
- For more information on Variable Rate Mortgages
|Bank of Canada
- The interest rate is higher than for a variable rate mortgage since you are benefiting from the stability of paying the same amount month to month regardless of whether the interest rates rise or fall.
- For more information on Fixed Rate Mortgages