How does the Bank of Canada interest rate affect you?
THE STACK #44The Bank of Canada recently reduced its key interest rate, creating a lot of buzz in the media.
You may be wondering what all the fuss is about and how this will affect you.
In today's issue, we will dive deeper into how interest rates are set and how this can impact you.
THE STACK
What exactly is the Bank of Canada, and what do they do?
The Bank of Canada is the central bank of Canada, responsible for conducting monetary policy, promoting a safe and sound financial system, and issuing and distributing the country's banknotes.
Its main objectives include keeping inflation low, stable, and predictable and contributing to the well-being of the Canadian economy.
Additionally, the Bank of Canada manages the government's foreign exchange reserves and provides liquidity and financial services to the government and financial institutions.
What does the Bank of Canada have to do with interest rates?
The Bank of Canada is like a big leader for all the banks in the country. It decides something called the "overnight rate," which is like a special interest rate.
When the Bank of Canada changes this rate, it affects how much it costs for banks to borrow money. The higher the overnight rate, the more expensive it becomes for banks to borrow money. This will make banks increase their interest rates, which can make it more expensive for people to borrow money for things like buying a house or a car.
So, the Bank of Canada has a big influence on how much it costs to borrow money.
So why does the Bank of Canada maintain such a high overnight rate, even though it makes borrowing more expensive for Canadians?
Everything was fine until COVID-19 happened. During COVID-19, inflation increased. Usually, when inflation increases, spending decreases. But because we were locked down, people kept spending money, and inflation was out of control. If the inflation rate continued increasing at that pace, it could have led to the economy's collapse. So, the Bank of Canada stepped in.
The Bank of Canada maintains a high overnight rate to control inflation and stabilize the economy. By making borrowing more expensive, it encourages spending to slow down, which can help prevent the economy from overheating.
Controlling inflation is a key goal for central banks, and adjusting the overnight rate is one of the tools they use to achieve this.
I understand now, but how does the change in the Bank of Canada's overnight interest rate affect me?
Borrowing Money
When interest rates go up, borrowing money becomes more expensive. This means that if you want to borrow money for things like buying a car or a house, you'll have to pay more in interest, making it harder to afford these things.
Savings
You may have noticed that your bank keeps increasing the interest rates on its savings accounts and GICs. This is because when interest rates go up, interest rates on savings accounts and GICs also increase. Higher interest rates can make it easier to save money because your savings can grow faster.
When the Bank of Canada interest rate decreases, you will also see a decrease in the interest rates that banks are willing to offer on savings accounts and GICs
Cost of Living
If you have a loan or a mortgage, higher interest rates might increase your monthly payments, making it harder to afford things in your daily life.
Economy and Jobs
When interest rates go up, it can make it harder for businesses to borrow money. If businesses can't borrow as much, it might slow down the economy and make it harder for people to find jobs.
Mortgage Rates
When interest rates go up, the interest on your loans, such as a mortgage, goes up as well. Most of you may have experienced your mortgage rate climbing up over the last three years.
Home prices
When mortgage rates go up, it makes it more difficult for people to afford to buy a home, which can ultimately reduce the demand for homes and lead to a decrease in home prices. So, on the one hand, you might have a lower down payment due to the lower home prices, but your monthly mortgage payments will be much higher.
On the other hand, when the Bank of Canada rate decreases, mortgage rates drop, and more people become optimistic about purchasing a home. This drives the demand up and leads to an increase in home prices, making homes unaffordable for others.
You can see why many have been excited about the Bank of Canada decreasing its interest rates. Many aspiring homeowners see this as a good sign, as mortgage rates will come down, and they can soon afford a house. But you also have to look at the flip side because this could lead to a further increase in home prices, making housing unaffordable.
When borrowing becomes cheaper, this will increase spending, potentially leading to higher prices for goods and services, causing inflation to rise.
Saving also becomes less desirable due to the low interest rates, which can impact long-term financial goals and stability.
THE TOOL
What’s behind your mortgage rate?
The Bank of Canada has a lot of great resources on inflation and interest rates. You will find this video on “What’s behind your mortgage rate” helpful
THE ACCOUNTABILITY
If you have been considering getting a GIC, you might want to act within the next week to secure your rates.
With the Bank of Canada policy rate decreasing, it means that interest rates on savings accounts and GICs will also decrease. You should start receiving notifications from your banks about the decrease in the coming weeks.
So, stop procrastinating and go lock in that rate!
THE COURAGE
THE KNOWLEDGE
Policy Rate
The policy rate, also known as the key interest rate, overnight rate or benchmark interest rate, is the rate at which a central bank lends money to the country's commercial banks.
It is a key tool used by central banks to implement monetary policy. Changes in the policy rate can influence the borrowing and lending rates throughout the economy, impacting consumer and business spending, investment, and inflation.
Prime Rate
The prime rate in Canada is the interest rate that commercial banks charge their most creditworthy customers for loans. It serves as a benchmark for many other interest rates in the country.
The prime rate is influenced by the Bank of Canada's overnight rate and is typically used for pricing variable-rate loans and lines of credit. It is an important indicator of borrowing costs for individuals and businesses in Canada.
The policy rate is set by the Bank of Canada and affects the banks while the prime rate is set by the banks and affects individuals and businesses
about the newsletterEvery Saturday, subscribers will receive one money tip, one tool, one actionable step, one word of courage and learn a new finance term to help you gain control of your finances in less than five minutes.
Free resources
Keep reading the latest NEWSLETTERS
How I manifested a girl's trip to Costa Rica