Prime rate drop, now what?

The Bank of Canada made a big announcement this week and dropped the overnight lending rate by 50 basis points to 1.25%.

Many banks and other mortgage lenders quickly reacted and also dropped their prime lending rate by 50 basis points to 3.45% other than TD Canada Trust that is higher at 3.60% for their variable rate mortgages.

It’s important to know that lenders control their prime lending rate, so you will have to wait for notification from your mortgage lender as not all lenders automatically lower their prime lending rate when the big banks do. It can take weeks or even months for some of the smaller credit unions and non-bank lenders to make any adjustments after the Bank of Canada has announced a rate change.

This is good news for those who have a home equity line of credit or a mortgage that adjusts with any changes in the prime lending rate. Your rate has just dropped by 0.5 per cent.

What should you know about this rate decrease, and what should you do – if anything?

The first thing you need to determine is whether you have a variable rate mortgage or an adjustable rate mortgage. Many believe that these two products are the same but they are not. The primary difference is how your payments are calculated which will determine what’s going to happen with your mortgage because of this rate decrease.

Here’s the difference:

Variable Rate Mortgage – the payment does not change when the prime rate decreases. The only time the payment would change is if interest rates rise so much that there is no principal reduction in the balance when a payment is made. Your payments won’t change.

Adjustable Rate Mortgage – the payment rises and falls with any change in the prime rate unless you have specifically requested that the payment be set at a specific amount. You should see some payment relief.

There are many strategies being recommended for variable and adjustable rate mortgage management, including making payments like you have a five-year fixed-term mortgage. The idea being that if you pay more then should interest rates rise you won’t be facing payment shock with a much higher payment at renewal time. Is it a good idea? Sure – why not, if you have nothing better to do with the extra funds? But it’s really just prepaying your mortgage.

Maybe a lower mortgage payment is best so you can pay off higher interest debt with the cash flow or invest the funds somewhere else for a higher rate of return on your money. 

Do have dead equity in your home? Perhaps it’s time to consider investing in real estate with these low interest rates. We will no doubt see a hot real estate market this spring with the now lower interest rates combined with a new lower mortgage stress test. Please reach out for a review and a mortgage preapproval so you are in the best position for a hot market.

Now that the rate has dropped on your mortgage, the best thing to do is have a review completed by your favourite mortgage broker. Have them crunch the numbers for you and discuss the best strategy to accomplish both your short-term and long-term goals. It’s a good idea to have a mortgage review regularly anyhow to ensure your current mortgage product is still working for you.

This article is written by or on behalf of an outsourced columnist and does not necessarily reflect the views of Castanet.