The overnight lending rate set by the Bank of Canada (BoC) directly influences variable-rate mortgages because it affects the prime lending rate that banks and lenders use to price their loans.
How It Works: Only affecting variable mortgage holders
Bank of Canada Sets the Overnight Rate:
This is the interest rate at which banks lend money to each other overnight to maintain their reserves. This is not a mortgage interest rate. The BoC adjusts this rate to control inflation and economic growth.
Lenders Adjust Their Prime Lending Rate:
The prime rate is the interest rate that banks offer to their most creditworthy customers.
Banks typically increase or decrease their prime rate in response to changes in the BoC's overnight rate.
If the BoC raises rates, banks increase their prime rate.
If the BoC lowers rates, banks decrease their prime rate.
Impact on Variable-Rate Mortgages:
Most variable-rate mortgages are tied to the prime rate (e.g., "Prime - 0.50%").
When the prime rate increases, mortgage payments go up because the interest rate on the mortgage rises.
When the prime rate decreases, mortgage payments go down, reducing borrowing costs.
Example:
Suppose the BoC raises the overnight rate by 0.25%.
Banks respond by increasing their prime rate by 0.25% (e.g., from 6.70% to 6.95%).A variable-rate mortgage at Prime - 0.50% would rise from 6.20% to 6.45%.
Borrowers pay more interest, increasing their monthly mortgage payment.
Why It Matters:
Higher rates discourage borrowing, helping to slow inflation.
Lower rates make borrowing cheaper, stimulating the housing market and economy.
Homeowners with fixed-rate mortgages are unaffected until renewal (like you), while variable-rate borrowers feel immediate changes.
So next time you hear about the Bank of Canada announcement, and you have a fixed mortgage - know it doesn't really apply to you. The overnight lending rate is not what the affective interest rate is for any mortgage products.