What is prime rate

What is prime rate

In the world of real estate, it is very common to hear the term prime rate. Many people are confused by this term. Prime rate refers to the lowest commercial interest rate charged by a bank at a particular time and it is used as the reference rate for the bank for all of its other rates. This prime rate is used as the starting point to calculate variable rate mortgages.

The bank has the power to set its own prime rate, but most of the times the prime rate among banks is identical.  Some people are under the impression that prime rate applied to “favourite customers”, meaning that those people with an outstanding credit or a lot of wealth were the only ones that would qualify for the prime rate. This was actually the case at one point in recent times, but it no longer applies. Nowadays, prime rate is usually available to everyone that qualifies for it.

The prime rate is affected by the overnight rate set by banks when loaning funds on a daily basis to other banks, and by the target overnight rate, used by the Bank of Canada as a means of controlling monetary policy. (Overnight rate is the interest rate at which large banks borrow money, short term, among themselves. A rise in the overnight rate will usually show a rise in the mortgage rates).Â

In most cases, the prime rate will change in the same direction and by the same amount as any change to the overnight rate. For instance, if the Bank of Canada announces a decrease to the overnight lending rate of one quarter of 1%, then you can expect the prime rate to drop by one quarter of 1%.

How does this prime rate look like when it comes to mortgages? If you choose a variable or an adjustable rate mortgage, or even a HELOC, the interest rates are based on the prime rate. However, fixed mortgage rates do not fluctuate with changes to the prime rate as they are determined by yields in the bond market.

Pick up a copy of Carmen Costa’s book “The Reality of Mortgages” to know more about this.