Prime Rate Canada

The prime rate is most commonly defined as the interest rate commercial banks charge their most credit-worthy customers. It serves as a benchmark rate for setting the rates on a variety of financial products, including mortgages, personal loans, and lines of credit. The prime rate is influenced by several factors, including inflation, economic growth, and the supply and demand for credit.

The prime rate is determined by the banks themselves, and is typically set at a level that is 1.5 to 2.5 percentage points above the overnight lending rate set by the Bank of Canada. The prime rate has been declining in recent months and is currently (as of March 12, 2025) 4.95%.

ach Canadian bank sets their own prime rate. They generally end up being the same rate, with no difference between the banks. Independent mortgage lenders do not set their own prime rate. They reference one or more of the big banks and use their prime rates as their reference prime rate.

The Bank of Canada's monetary policy is a key determinant of the prime rate even though it does not directly set it. The Bank of Canada uses its benchmark overnight lending rate to regulate the nation's economic growth and restrain inflation. The Bank of Canada influences short-term interest rates by adjusting the target for the overnight rate on eight fixed dates each year.

When the Bank of Canada changes the overnight rate, the Canadian banks usually change their prime rates within a couple days. They tend to move their prime rates by the same amount and in the same direction that the Bank of Canada moves the overnight lending rate.

Banks use the prime rate as a benchmark rate for a variety of financial products, including mortgages, personal loans, and lines of credit. The interest rate charged for these products is typically set at a margin above or below the prime rate. Most products will have a rate of Prime plus a margin but variable rate mortgages for the best borrowers are usually priced at Prime minus a margin. For example, a bank might offer a variable-rate mortgage at a rate of prime minus 1% (equal to 3.95% today). As the Prime Rate moves up or down the variable mortgage rate will move also, but the margin stays the same for the term of the mortgage.

Variable mortgage rates are directly tied to the prime rate. When the prime rate goes up, so does the interest rate on a variable rate mortgage. Conversely, when the prime rate goes down, so does the interest rate on a variable rate mortgage. This means that borrowers with variable rate mortgages are exposed to interest rate risk, as their mortgage payments can increase if the prime rate increases.

The margin relative to the prime rate depends on market conditions, the risk profile of the borrower and the costs of lending. When market conditions are positive, the margin for the best borrowers can be as much as minus 1.50%. When market conditions worsen, that margin can be as small as 0.25% to 0.50%.

As an example, using today’s prime rate, the rate on a variable rate mortgage might be 3.95%:

4.95% - 1.00% = 3.95%

If the prime rate was reduced by 0.25% to 4.70%, the rate on a variable-rate mortgage would become:

4.70% - 1.00% = 3.70%

The margin of 1.00% stays the same for the term of the mortgage but the mortgage rate will change when the prime rate changes.

The prime rate is usually the same for all banks. They will use this base prime rate for pricing variable rate mortgages and the competitive difference in rate is the margin below the prime rate that they offer. However, there is one bank that does things differently. TD Bank uses a prime rate for mortgage lending that is equal to their prime rate plus 0.15%. They have been doing this since 2016. Borrowers should note this since TD needs to offer a larger margin discount to their prime rate to get you to the same rate being offered by other lenders.

The prime rate fluctuates over time. There have been significant increases in the past, primarily due to central bank efforts to tame inflation, very similar to what happened in Canada in 2022. The current prime rate seems very high but is it really that high when compared to the past? The answer is yes, when you compare it to recent history. However, the business and interest rate cycles run over a long time period and when you look back further in history, today’s prime rate looks

The historic margin between variable mortgage rates and the prime rate has varied over time. In general, the margin tends to be a discount ranging between 0.5% and 1.5%, depending on market conditions and the risk profile of the borrower. During times of economic uncertainty or when credit conditions are tight, banks may offer less of a discount margin to account for increased risk.

Predicting where the prime rate will go in the future is difficult. It is influenced by a wide range of factors and, as we saw in 2022, can be subject to sudden changes. Some economists and analysts use models to forecast the future direction of interest rates, but these projections are often imprecise and subject to error. Ultimately, the direction of the prime rate will depend on a variety of economic factors that influence the rate setting policy of the Bank of Canada, including inflation, economic growth, and the supply and demand for credit.

Trying to predict the future direction of interest rates can be a risky exercise for a mortgage borrower. Just look at what happened to variable-rate mortgage holders in 2022. Many took out variable rate mortgages when rates were very low and are now experiencing financial stress due to higher rates. A fixed-rate mortgage would have been a better decision. Looking at a variable-rate mortgage as an opportunity to benefit from rates declining without considering the risk if

rates were to increase is a poor analysis. The best analysis for most of us is to find the rate that we can afford that we can lock-in for as long as possible. Making a bet on Interest rates is arguably inappropriate for a homeowner that is trying to secure financing for their house. It is a material risk. Assess your risk tolerance and understand what happens if your bet on rates does not work out. Taking interest rate risk is only appropriate for the minority of us that can afford to be wrong.

The Bank of Canada lowered its overnight policy rate by 0.25% on March 12, 2025 from 3.0% per cent to 2.75%. This is their seventh consecutive cut and comes amid slowing economic momentum and growing uncertainty over tariff tensions. While this is good news for variable-rate mortgage borrowers it is indicative of darkening economic clouds hanging over Canada.

After the rate cut in January, the market expected steady economic growth and at least a brief pause in further cuts. A political environment that creates uncertainty can curb economic activity, as slower than expected Q1 economic growth demonstrates. The fear and uncertainty has escalated in the past month and we may see reduced economic activity until it settles down. The Bank of Canada referred to the uncertainty from the tariff showdown as a key reason for this cut.

The prime rate and variable mortgage rates will decline by 0.25%, bringing some relief to variable-rate mortgage holders. Variable mortgage rates are now very close to fixed mortgage rates, but still slightly higher. With the additional rate cuts that are anticipated we could soon see a more typical rate environment where variable rates are below fixed rates, perhaps into the mid-3% range by the end of the year.

Bond yields have not changed as a result of this rate cut - it was already priced in. Fixed mortgage rates are based on bond yields not the Bank of Canada rate. Bond yields are lower by 0.20% since the last rate cut on January 29. Some lenders have lowered their fixed rates a bit in the past couple weeks but we see them stabilizing in a tight range near current levels. Economic news and the outcome of the ever-changing tariff debate will have more impact on fixed rates than the Bank of Canada.

In their accompanying statement the Bank of Canada stated that "The Canadian economy entered 2025 in a solid position, with inflation close to the 2% target and robust GDP growth. However, heightened trade tensions and tariffs imposed by the United States will likely slow the pace of economic activity and increase inflationary pressures in Canada. The economic outlook continues to be subject to more-than-usual uncertainty because of the rapidly evolving policy landscape."

They also stated - "While economic growth has come in stronger than expected, the pervasive uncertainty created by continuously changing US tariff threats is restraining consumers’ spending intentions and businesses’ plans to hire and invest. Against this background, and with inflation close to the 2% target, Governing Council decided to reduce the policy rate by a further 25 basis points".

The economic uncertainty related to tariffs and the potential inflationary impact they may have will make the Bank of Canada's job more difficult in the coming months. As the Bank of Canada has said "Monetary policy cannot offset the impacts of a trade war".

Tariffs imposed by the US and the counter-tariffs from Canada will both increase costs for homebuilders and threaten job security in several industries. Neither of these are positive for the housing market. The housing market has been leaning toward a buyer's market and those that can afford to buy in this environment, now at lower rates, can take advantage. Others may choose to stay put for now until the uncertainty fades. Either way, talk to an experienced advisor and proceed carefully.

The prime rate at the banks will now decline from the current 5.20% to 4.95%.

You can read the Bank of Canada's full press release here -

https://www.bankofcanada.ca/2025/03/fad-press-release-2025-03-12/

The next Bank of Canada rate announcement is scheduled for April 16, shortly after the next round of US tariffs are scheduled to arrive.

Final Word

The Canadian bank prime rate plays an important role in the country's financial system, serving as a benchmark rate for a variety of financial products. While the Bank of Canada does not directly set the prime rate, it does have an indirect influence on it through its monetary policy. Banks use the prime rate as a basis for setting interest rates on loans and lines of credit, and borrowers with these variable-rate products, such as variable-rate mortgages, are exposed to

interest rate risk. While predicting the future direction of the prime rate is difficult, understanding how it is determined and how it is used by banks and borrowers can help individuals make informed financial decisions.

If you have a variable rate mortgage you need to be aware that rates may unexpectedly increase. Expectations are that rates will decline further in 2025 and while this seems likely, the current geo-political environment is uncertain and the risks are high. Manage your own affairs without trying to guess where rates are going. Variable-rate mortgages contain risk and are not for everyone.

If you are in the market currently for a mortgage, a fixed rate might be the best solution. With no exposure to interest rate risk during the term of the mortgage, a fixed-rate mortgage is the conservative choice for the majority of us that have a low risk tolerance.