Prime Rates are down, will my fixed rates go down to?

When the prime rate drops, those with fixed-rate mortgages might wonder, "do we get a break too?"

Understanding Fixed vs. Variable Rates

• Fixed-Rate Mortgage: With a fixed-rate mortgage, your interest rate is locked in for a set term—typically 3, 5, or even 10 years. This rate won’t change during the term, providing stability and predictability in your monthly payments.

• Variable-Rate Mortgage: With a variable-rate mortgage, the interest rate can change periodically. It’s often based on the lender’s prime rate, which fluctuates with changes in the Bank of Canada’s policy interest rate. As a result, monthly payments can vary over time.

Why Do Variable Rates Change?

Variable rates are tied to the Bank of Canada’s overnight lending rate, which is the rate at which banks borrow money from each other overnight. The Bank of Canada adjusts this rate in response to economic conditions, primarily to control inflation and maintain economic stability. When the overnight rate changes, it directly affects the prime rate offered by lenders, which in turn influences variable mortgage rates.

For instance:

• If the Bank of Canada raises its overnight rate, lenders usually increase their prime rate. This leads to higher variable mortgage rates, which can increase monthly payments for borrowers.

• If the Bank of Canada lowers the overnight rate, lenders may reduce their prime rate, resulting in lower variable mortgage rates and potentially lower monthly payments for borrowers.

Because variable rates are linked to the prime rate, they can change multiple times over a mortgage term as the economy shifts.

Why Don’t Fixed Rates Change?

Fixed rates are based on longer-term bond yields, particularly government bond yields, which reflect economic conditions and inflation expectations over a longer period. When you sign a fixed-rate mortgage, the lender guarantees a specific interest rate for the duration of the term, regardless of fluctuations in bond yields or the Bank of Canada’s rate decisions.

The fixed rate you receive is determined at the time you take out the mortgage, based on bond yields at that time, plus a margin added by the lender. This rate doesn’t change during the term because:

• Risk and Predictability: The lender assumes the risk of locking in a rate for you, and in exchange, you gain predictability. Your payments stay consistent, regardless of market changes.

• Pre-Set Terms: Fixed-rate terms are structured to provide stability to borrowers, which is especially valuable for those who prefer predictable costs. Any shift in bond yields or market rates affects only new fixed-rate mortgages, not existing ones.

Conclusion

Variable mortgage rates fluctuate in response to changes in the Bank of Canada’s policy rate, while fixed rates remain constant throughout the mortgage term. Understanding this difference can help you make an informed decision based on your financial needs and comfort with risk. Whether you choose the stability of a fixed rate or the potential savings of a variable rate, knowing how each works will ensure you’re prepared for any rate changes down the road.