The current Prime Rate in Canada sits at 3.95%. Also known as the prime lending rate, it serves as a key lending rate used to set many different interest rates, such as the rates on credit cards, mortgages and car loans.
Prime Lending Rate changes over time as you will see in the graph below which details the historic changes from 2015 to date. For now, read and understand.
I am sure you’ve heard people worrying about the upcoming Bank of Canada interest rate announcement. That is because a high interest would increase the bank’s cost of lending, in turn, every other loan would become more expensive.
What is the prime rate?
Now that you know that it is important and that it affects you on a daily basis, what is it?
Obviously ‘Prime Rate’ is not a term you get to hear every day except of course if you love watching news unlike the rest of us who spend our time binge-watching Netflix.
However, it is of paramount importance that you know what it is.
It is quite unfortunate that these boring things always seem to be important. Being a good friend that I am, I, therefore, made it my business to get you the best available definition.
According to Investopedia, the prime lending rate is the interest rate that commercial banks charge their most creditworthy corporate customers.
The federal funds overnight rate serves as the basis for the prime rate, and prime serves as the starting point for most other interest rates.
Does that sound too difficult?
When I first heard that definition when I was at school, I also had a hard time understanding as well. So do not despair if you didn’t understand it.
Think of it this way: whenever you apply for a loan from your bank, the interest they charge you is dependent on the Prime of the bank. If it is high, your loan will also be high.
Almost every other loan’s interest rate calculation derives its existence on the prime interest rate. Be it vehicle financing, mortgage, credit cards, and other personal loans
If you still don’t understand, just remember that whenever they reduce it, it is good for you. But if they increase it, that’s bad for you, you can start preparing placards fo the next protest.
How is the Prime Rate in Canada calculated?
So where does Prime Rate come from?
Each bank has its own Prime Lending Rate, it is, therefore, not universally calculated. However, there is a basic understanding that every other bank factors in the number of its defaulting clients.
This is due to the fact that rarely does the most creditworthy client default. If the number of defaulters increases, the prime lending rate goes up and if it is low, the opposite is true.
The other key factor if not more important than the first is the calculation of the Bank of Canada policy interest rate.
This is to say when it becomes expensive for banks to borrow money, they, in turn, increase the Prime Rate. Again the opposite is true.
Regardless of the fact that each bank calculates its own rate, the Big five banks tend to use the same rate.
How does it affect you on a day to day basis?
As I have already explained above, banks base most of their lending rates on the cost of their borrowing. That includes adjustable-rate loans, interest-only mortgages, and credit card rates.
Their rates are a little higher than prime to cover banks’ bigger risk of default. They’ve got to cover their losses for the loans that never get repaid.
The riskiest loans are credit cards. That’s why those rates are so much higher than prime.
I am sure you remember those days when thinks where cheap, you could get a mortgage at a very low cost. That’s because the Prime lending in Canada was generally low.
This is how Prime Rate change affects you:
The prime rate affects you when it rises. When that happens, your monthly payments increase along with the prime rate.
Pay close attention when the Bank of Canada is raising the fed funds rate. It means your costs are about to go up.
I am sure this helps you understand why politicians always talk about Interest Rates during election campaigns. Well, don’t listen to them, they don’t control the interest rates, that’s a preserve for the Bank of Canada.
Anyways back to the point, the prime rate also affects liquidity in the financial markets. A low rate increases liquidity by making loans less expensive and easier to get.
When prime lending rates are low, businesses expand and so does the economy. Similarly, when rates are high, liquidity dries up, and the economy slows down. 
My dear friends, it would be wrong for me to conclude this article without showing you how Prime Rate in Canada has changed over time.
Considering how I love keeping you informed I have prepared this chart to demonstrate the historical prime rates.
It has been fluctuating over time, ranging from terrible historic highs around 23% in the early 1980s to mouth-watering lows of 2.25% after the great recession.
Nonetheless, that’s all in the past, this graph will take you from 2015 to the current Rate.
Lastly, a bit of good news, if economists are anything to go by, there is a consensus that by year-end it will go down from 3.95 to about 3.70.
This is not a consensus amongst local economists, I wouldn’t trust them. Many economists around the world share this prediction.
So not all is doom and gloom in Canada. Better days are waiting for us ahead.