That’s why changes in the overnight rate prompt a sort of domino effect on variable-rate loans offered by banks—their interest rates are typically expressed as “prime plus or minus” a percentage. For example, a bank may offer a product at a rate of “prime minus 1%.” At a prime rate of 2.45%, a product listed at “prime minus 1%” would mean the customer pays 1.45% in interest.
How does a change in the interest rates impact you?
When prime rates increase or decrease, so do variable rates. This domino effect can impact borrowers with a variable-rate mortgage, home equity line of credit (HELOC), student loan, line of credit or another type of variable-rate loan. Mortgage analyst Robert McLister noted that “a 25 [basis points] boost to prime lifts payments on adjustable-rate mortgage payments by roughly $12/month per $100,000 of borrowing.” With a hike of 75 basis points, payments on variable- and adjustable-rate mortgages typically climb $42 per month for every $100,000 borrowed, according to the expert.
“If the prime rate goes up by 1%, people who are spending a couple thousand dollars a month on their mortgage could see that [amount] rise substantially,” says Jesse Abrams, CEO of online mortgage broker Homewise. “Over five years, we could be talking $30,000 to $40,000. That extra 1% can be pretty significant.”
Variable-rate mortgage holders: With the Bank of Canada (#BoC) hiking the overnight rate another 75 basis points on Wednesday, what’s your next move?
— MoneySense (@MoneySense) September 8, 2022
However, this does not apply to borrowers with a fixed-rate loan, such as a fixed-rate mortgage. A fixed rate is “locked in,” meaning the rate is guaranteed by the lender for the duration of the loan or mortgage term. In this instance, the borrower continues to pay the same rate regardless of what happens in the mortgage market.
Changes in the prime rate also influence the interest earned in high-interest savings accounts (HISAs) and other investment vehicles, like guaranteed investment certificates (GICs). When the overnight rate increases, individuals can earn higher interest on their savings, because financial institutions have more latitude to compete on the interest rates they offer. Conversely, individuals who are retired or living off fixed income from a savings fund can be negatively impacted when the overnight rate drops.
What should you do in response to changes to the overnight rate?
To prepare for rate changes, start by keeping track of the next policy rate announcement, then anticipate and plan around what an increase or decrease in the rate will mean for your finances.
If you have a variable-rate mortgage, you can use a mortgage payment calculator to determine what your new recurring payments will be. It may be time to consider locking into a fixed-rate mortgage. And if you’re retired or planning to retire soon, you may wish to speak to a financial planner about your options.
What the future holds relies heavily on the stability of the Canadian economy. The BoC’s interest rate was slashed to historic lows when the economy needed a boost, and a gradual return to higher rates suggests the economy has recovered—and is now in overdrive. So while higher rates could make borrowing and paying off debt more difficult, for many people, they may also be a sign of better times ahead.