Falling Rate Drop

Falling Rate Drop

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The Bank of Canada influences interest rates for consumers and businesses.  The Bank sets the rate that financial institutions charge each other.   The “overnight rate” is the foundation that all other rates, like mortgages, home equity loans, credit cards, car loans, commercial mortgages, and lines of credit are based upon.  It is also the foundation for deposits, like GICs (Guaranteed Investment Certificates), bonds, and savings accounts.

When the Bank lowers its “overnight rate” all lending and borrowing is eventually affected, some instruments react quickly and others react more slowly, but when the “overnight rate” is lowered by the Bank of Canada, interest rates seen by consumers and businesses eventually fall.

What You Need to Know

Lower interest rates for borrowers will:

• Decrease payments for variable rate loans with variable payments, like credit cards and lines of credit, or an adjustable payment mortgage with fixed principal repayment and variable interest.

• Decrease interest charges and increase principal repayment for fixed payment, variable interest rate mortgages.

• Decrease payments at renewal for fixed payment loans, like a residential mortgage.

  • Provide an opportunity at renewal to maintain payment level, which increases principal repayment further, lowering overall interest paid over the reduced life of the loan.

• Not affect loans with fixed rates and locked-in for a specified term, like a 5-year mortgage only 2 years into its term

  • Generate penalties and costs which must be factored into the decision for an early renewal that could lower payments or interest charges.

• Lower the cost of borrowing for margin loans in a brokerage account.

Lower interest rates for depositors will:

• Reduce interest income earned on variable rate deposits, like savings accounts.

• Increase prices of existing fixed rate bonds traded in the market, aligning their yield to the prevailing yield of new bonds.

• Lower interest earned on new, fixed term deposits like GICs.

• Not affect fixed interest rate investments like GICs with time remaining on their terms

When rates fall, borrowers and lenders, pay and receive less interest.  This reduction typically increases spending on other goods and services and can spark increased overall economic activity.

The Bottom Line

Overall, lower rates are better for payers of interest (borrowers) than for earners of interest (depositors), but everyone is affected differently and at different times.  Regular reviews of holdings within an investment portfolio are necessary, especially during periods with falling interest rates.  Although advantageous rates may have been locked-in, and moves may not be possible or positive.  Preparing for changing conditions facilitates decisions based on rational analysis.