Subtitle: And the 1 Thing That Did.
Since the Bank of Canada dropped the overnight rate to 1/2 a percent on July 15th 2015, I have been receiving a lot more phone calls and emails than usual, people want to know what this means to them. Unfortunately there is a lot of misinformation floating around, so I thought I would clear the air and share the 7 most important things you need to know about the recent drop in the overnight rate.
1. The overnight rate is NOT the prime rate.
The change by the government to the overnight rate has no direct impact to mortgage rates. “Changes in the target for the overnight rate influence other interest rates, such as those for consumer loans and mortgages.” Bank of Canada.
So basically the overnight rate can influence the prime lending rate, but it doesn’t have to… the banks decide that for themselves and subsequently for us.
2. A drop in the overnight rate does NOT mean banks will pass along the savings intended for you.
Although historically the Banks have followed suit by moving the prime rate in step with the overnight rate, they broke this pattern on January 21st 2015, when the overnight rate fell by .25% while the banks only dropped by .15%. You can read my thoughts on that decision here.
Subsequently, the next time the overnight rate dropped (the announcement on July 15th 2015) the same thing happened, overnight dropped by .25% while the banks lowered .15%. You can read more about this one here in an article called did you just get robbed by your bank.
3. Fixed rate holders are NOT affected by any of this.
If you have an existing mortgage with a fixed rate, nothing happens to your mortgage. Also, if you are looking to take out a new fixed rate mortgage, the rates have not changed. The overnight rate influences the prime lending rate, which is used for variable rate mortgages. Not fixed rate mortgage. Fixed rates are influenced by the bond market.
4. You will NOT qualify to borrow more money because of this.
It might make sense that because you hear “rates have gone down” you will “qualify to buy a bigger house”. Nope. That’s just not how it works. When you are purchasing a house and taking a variable rate mortgage, you have to qualify for the purchase at the benchmark rate which is considerably higher than the rate on your contract. You can read more about that here.
5. You aren’t going to “get a better deal” because any of this.
Probably the biggest misconception out there right now is the idea that because “rates have gone down” you should be “able to get a better deal”. Nope. That’s not how it works. As we have already established, the overnight rate influences prime rate, and does nothing to fixed rates. Further to that…
A variable rate is calculated by taking prime and then adjusting it with what is called a “component to prime”. It can be plus or minus a percentage and the banks decide what it will be. Currently lenders are offering a discount from prime, lets say it’s .50%, so as Prime is 2.70%, and as the lender will discount that by .50%, your contract rate would be 2.20%. The drop in overnight rate did not have any affect on the discount or component the bank was offering.
6. The sky is NOT falling.
Always remember that it is the media’s job to get you to pay attention to them. They will take any opportunity to turn anything into a story. I am not going to get into the impact the overnight rate has on the economy and what that may or may not mean to the future of this country, all I will say is that the real estate market in Vancouver is hot. We are seeing multiple offers on properties and it doesn’t appear to be slowing down any.
So what impact did the recent drop actually have?
1. If you are an existing variable rate holder, the interest you are paying on your mortgage just went down. A little.
Obviously it would be nice to see the full .25% passed along, but the .15% you did get is nice. I suggest you take advantage of this and keep your payments the same and put this savings directly towards the principal repayment of your mortgage. If you want to know how to do this, give me a call, I would love to help!
That’s it. Honestly, there is a lot of noise surrounding this move more because the banks are being greedy than any impact it would have on your financial future. If you would like to know more, contact me anytime, I would love to answer your questions!