First-Time Home Buyer


What is Interest Rate?
“Bank of Canada holds interest rate steady” What does it mean to you? Bank of Canada cut its overnight lending rate two times already this year.

As the economy slid and the price of oil falls so does the Prime Rate. With Bank of Canada cutting its overnight lending rate so does the borrowing cost to all Canadians.

Why cut rate?

During recession, the supply of money increases because people tend to save and hold on to heir money. The economic uncertainty encourages individuals to save money and prepare for the slowdown thus the supply of money increases.

The benefits of interest rate cut?

With the overnight lending rate cut to a new low, the borrowing costs of Canadians will also decrease. Major Banks will adjust to the rate cut by lowering the prime rate. What this mean to all of us is lower cost to borrow money. Any borrowing product that is tied to the prime rate will see the direct benefits. This would be variable loans or variable mortgages.
In order to induce spending, interest rate is cut. This means cheaper to borrow in hopes to encourage spending and start up the economy.
However, due to lower borrowing costs Canadians are borrowing over their head and risks being over –extended. According to new study, Canadians are borrowing a record 163.6% over their disposable income (this is the income after all expenses).
The main source of borrowed funds is the equity of residence. This is typically tied to the prime rate which allows more Canadian to borrow. Home equity increases when value of home increases.

The drawbacks of cutting rates

With lower interest rates comes lower income for individuals that rely on interest earn. Lower interest means low investment returns on product like Guaranteed Investment Certificates (GIC’s). Retirees then reduce spending which result to lower economic activity.
Additionally, Investors stop investing which further slows economic activity. Investors look for other attractive product outside of the country to get a higher return on their investments.
Furthermore, borrowing becomes more difficult due to lower spread that affects financial institution’s profitability. The lower rates will also increase potential for inflation. The increase supply of money decreases its value. All things equal, money that you are sending outside of Canada has lower value.
Randy Dagasdas, BComm.(Hons), FCUIC, ACUIC(Hons)

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