What is Prime Interest Rate?

Prime interest rate or prime lending rate is a term applied in many countries to a reference interest rate used by banks. The term originally indicated the rate of interest at which banks lent to favoured customers like those with high credibility. Historically, in North American banking, the prime rate was the actual interest rate although this is no longer the case. The prime rate varies little among banks, and adjustments are generally made by banks at the same time, although this does not happen with frequency. The prime rate in Canada is currently 3.00%.

This article discusses the following points:
  1. Prime Lending Rate in Canada

  2. Influences of the Prime Rate

  3. Effects of Prime Rate on Consumers

What is the Prime Lending Rate in Canada?

The Prime Lending Rate in Canada is a guideline interest rate charged by banks on loans for their most creditworthy clients. The actual minimum rate may differ slightly from lender to lender. Banks and lenders in Canada follow the prime rate in order to remain competitive. When the prime lending rates are high, many lenders in Canada offer variable rates at prime minus. If the prime rate is low, lenders could potentially offer variable rates at prime plus a percent. This model of prime rate tracking allows lenders to remain highly competitive while still adhering to the fluctuating interest rate of prime.

What are the Influences of the Prime Rate?

Canada’s prime rate is influenced primarily by Canadian economic conditions. The Bank of Canada adjusts it directly, depending on the state of the economy. The Bank of Canada decides what interest rate prime should be set at and for how long. This is vital to the growth and stability of the country.
Economic conditions in a country like Canada directly affect the ability of banks, companies and consumers to spend money or to provide goods and services. These ups and downs are driven by various factors in employment, manufacturing and exports. All of these things, taken together, affect the inflation rate. When inflation is high, the Bank of Canada must act quickly to avoid an overheated economy. In this case, they react by increasing the prime rate, thereby making the act of borrowing money more expensive. This has the effect of cooling off the economy so as to control the rate of inflation. Likewise, in cases where inflation is low, the Bank of Canada will decrease the prime rate, so as to heat up the economy.
The prime rate only changes when the Bank of Canada decides it is necessary to boost the economy or to slow it down. In November of 2000, the Bank of Canada introduced eight fixed dates each year where they would announce any rate changes. Announcements for changes of many other Bank of Canada-influenced rates, such as the overnight rate target, also share the same dates. These dates do not necessarily guarantee any movement of the prime. They are simply dates on the calendar where the prime rate can be changed if required.

What are the Effects of Prime Rate on Consumers?

Canadian consumers and enterprises cannot always pay cash all the time. Therefore, they need to borrow in order to purchase more costly goods or services. This is where the prime rate is vital to the operation of any household or business. In one way, shape, or form, this interest rate affects almost everyone’s daily life, not just a borrower.
When you are in the market for a particular product built by mass manufacturing, it is highly probable that companies creating these products used borrowed funds. These borrowed funds typically come from a bank or lender where the prime rate is used as the most basic and proportionate factor for calculating interest charged on the loan. If you choose to finance your vehicle, the dealership's financing department base their auto loan rates on a calculation using the prime rate.
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 which is 3 or 5 years in length. Today, the prime rate is set at 3.00% and the best variable rate is 3.10%. The 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.

Changes in Prime Rates

Variable mortgages or lines of credit follow the prime rate in Canada. The variable rate or calculation for your line of credit interest changes if there is a change in prime rates. Make sure you understand the prime rate and how it is tied to the monetary system.


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