Pattie Lovett-Reid: How higher rates may affect you
Once the Bank of Canada moved its benchmark rate higher it took only a couple of hours for the big banks to follow suit by raising their prime lending rate 25 basis points from 2.7 to 2.95 per cent.
The question is who really borrows at prime anyway? The term prime rate refers to the interest rate that banks charge their preferred customers, or those with the highest credit ratings. It is used to determine borrowing costs on many short-term loan products.
Banks use the prime rate to set interest rates on numerous short-term loan products. These include variable-rate mortgages, auto loans, credit cards and home equity loans.
The terms of such loans typically are expressed as prime plus or minus a certain percentage, depending on the borrower’s credit rating and other factors. For example, someone considered a good credit risk may qualify for “prime plus one per cent.” or maybe even just “prime”.
So what does this mean to the rest of us who may not be a preferred customer:
- If you are a borrower with a variable rate tied to prime, your costs are going higher and more of your payment will go towards paying off interest versus principle.
- If you have a fixed term rate mortgage you have some breathing room until you are up for renewal.
- If you have a variable-rate mortgage that is based on your lenders prime rate, this is where the impact on your payments happen. You could be plus- or minus-prime based on the discount you negotiated. Payments on most variable-rate mortgages will be adjusted higher to reflect the increase in the bank’s prime lending rate.
Not all variable-rate mortgages payments will be adjusted and here’s why: As rates go higher, more of your payment goes toward paying interest and less goes toward principle resulting in a longer period of time to pay it off.
We often use the term “variable-rate mortgage” to describe and lump all mortgages together where rates can fluctuate during the term of the loan. However, “adjustable-rate mortgages” are where the payments are reset when your lenders prime rate changes.
Bottom line: With a variable-rate mortgage your mix of principle and interest changes not the amount of the payment.