If you’ve ever considered taking a loan from banks or other financial institutions, then you’re probably familiar with the term “prime rate.” Prime rates have a massive impact on almost all lending products and, thus, your financial life in general.
They influence the interest rates at which banks and other lenders offer loans and other lines of credit. So what exactly is a prime rate, and what does it mean for you?
What is the Prime Rate?
The prime rate, also sometimes called the “prime lending rate,” is the yearly interest rate that major Canadian banks and financial institutions, like TD, base their borrowing rates for variable loans and lines of credit, such as mortgages and auto loans.
How Does the Prime Rate Work?
To clarify, if you apply for a car loan or a mortgage and you decide on a variable interest rate, the interest rate the bank will offer you will be its prime rate, plus or minus a percentage. Since Prime rates are subject to change, so is your variable interest rate, moving up or down the same amount as the bank’s prime rate.
Variable rates are usually lower than fixed rates. They can also always go even lower if the prime rate falls, but the possibility of the prime rate increasing makes it unappealing for risk-averse people. Prime rates do not apply to fixed interest rates, and fixed interest rates do not change regardless of the bank’s prime rate. Most lenders allow customers to convert variable-rate loans to fixed-rate loans at any time, but the customers have to pay the fixed rate when they decide to switch.
How Does the Prime Rate Affect You?
Ideally, the prime rate is reserved for customers who are considered “most qualified.” That is customers who pose the lowest loan default risks. These “qualified” customers are usually corporations and stable businesses who are most likely to repay their loans. For less qualified customers, that is, people more likely to default on payment; the interest rates offered are typically higher than the prime rate.
Regardless of the prime rate, banks and other lenders may still offer lower or higher rates. This is because the prime rate is used only as a benchmark. While it is usually the lowest rates lenders will offer, it should not be seen as the mandatory minimum. Lenders may offer lower than the prime rate to customers whom they consider to be very low risk.
As of this moment, on February 24th, 2021, the prime rate is 2.450%. So, if you apply for a loan now, let’s say a car loan, and you opt for a variable interest rate, your variable interest rate, depending on your creditworthiness, will be the prime rate +/- a percentage. Let’s assume you get approved at Prime rate + 0.4%. This would mean that your interest rate is effectively 2.850% (i.e. 2.450% + 0.4%).
If the prime rate then increases by 0.5%, that is from 2.450% to 2.950%, then your variable interest rate of (Prime + 0.4%) will also increase by 0.5%, from 2.850% to 3.350%. If the prime rate instead decreases by 0.5%, your variable interest rate would fall by the same margin.
Note that some banks don’t base their interest rates on the prime rate. International banks and banks that cater to many foreign customers use what’s known as the London Interbank Offered Rate (LIBOR).
LIBOR is the rate at which banks charge each other for short-term loans. Both the LIBOR and the Prime Rate tend to move in tandem. However, since the 2008 financial crisis, LIBOR has lost favor in the financial market. Banks have been replacing LIBOR with Alternative Reference Rates (ARR) and gradually phasing it out.
It was found to lack transparency and also to be vulnerable to manipulation. Also, as the number of transactions decreased significantly, it was deemed to rely too heavily on subjective judgment.
Financial products with variable rates which are influenced by the prime lending rate include
- Personal loans (credit cards)
- Loans for small- and medium-sized enterprises (SMEs)
- Auto loans
TD Bank Prime Rate
TD Bank, one of Canada’s “BIG 5,” is also the 12th largest bank in the world. It’s come a long way from its humble beginnings in 1855, when it started as a single-branch bank serving merchants. It now has branches in several countries and operates on a truly global scale. TD bank offers a diverse range of financial services to its massive, worldwide customer base, including commercial banking, insurance products, capital markets, retail banking, etc.
TD Bank offers a variety of loan services, and as a result of its size, it reaches a multitude of people and thus is one of the most popular and most accessible lenders in Canada. TD Banks offers both variable and fixed interest rates. While the prime rate may still influence fixed interest rates, they do not change and can no longer be affected by the prime rate once set.
Variable rates, however, are always subject to change due to variations in the prime rate. Having already discussed the prime rate, we will now discuss TD Bank’s Prime Rate in detail.
As of today, February 24th, 2021, TD’s prime rate is set to 2.450%.
This is the lowest prime rate in recent times and one of the lowest ever. The prime rate was 3.950% until it changed three times at the beginning of the pandemic in March last year, first to 3.450% on March 5th, then 2.950% on March 17th, before settling to its current rate of 2.450% on March 30th, 2020.
The reason for the historically low prime rate is the Covid-19 pandemic. The Bank of Canada (BoC), in the first quarter of 2020, decreased the target overnight rate from 1.75% to 0.25% in an attempt to lessen the economic hardship caused by the pandemic.
The table below shows how TD’s Prime Rate has changed over the past decade.[table “127” not found /]
Stand-out Prime Rates in History
Prime rates have greatly varied over time. In the early 1980s, it was as high as 23%, and then in the years following the great recession, it fell as low as 2.25%.
TD Bank Prime Rate for Mortgages
TD Bank is different from other lenders because it uses a different prime rate for its mortgage loans. On February 24th, 2021, the TD Bank prime rate for mortgages is 2.60%. Despite being a different number, the mortgage prime rate works in the same way as the normal prime rate.
Disclaimer: Rates and product offerings are always changing, so this article might not reflect the current market situation. Please contact your financial advisor before making any financial decisions.
What determines TD’s prime rate?
The cost of borrowing primarily determines a bank’s prime rate. The borrowing cost for banks is determined by the Bank of Canada (BoC) and is represented by the target overnight rate. A high target overnight rate means it’s costlier for banks to borrow money. So they raise their prime rates to cover new costs, and a low target overnight rate means it’s cheaper to borrow, and thus, banks reduce their prime rates, usually by the same amount as the target overnight rate reduction.
What is the target overnight interest rate?
The Bank of Canada sets it. The target overnight interest rate determines the cost of lending money for the major financial institutions in Canada. It is an indicator of the health of the economy. The financial institutions set their prime rates based on the target overnight interest rate. When the target overnight rate changes, lenders will typically follow suit and adjust their prime rates within a few days.
Which bank has the lowest prime rate?
While each of Canada’s biggest banks sets its prime rate, they’re usually all set to the same percentage, dependent on the target overnight rate. The following banks all share the same prime rate of 2.450%; TD Bank, RBC, Scotiabank, BMO, National Bank, Tangerine, HSBC, and CIBC.
When will the prime rate change again?
The Bank of Canada (BoC) is scheduled to hold an additional three policy meetings this year. However, they have signaled that they do not expect to raise rates until 2022 at least.
The next BoC meeting is scheduled for March 10th, 2021. If they decide to change the target overnight rate, then the prime rate will most likely follow suit.