How do low interest rates affect your life?
The Bank of Canada cut its key interest rates to 2.25 per cent on Wednesday, continuing a rate-cutting cycle that began in June 2024.
Ahead of this latest change, CBC News spoke to economists, mortgage experts and financial planners who explained how interest rates work and what they look for with each Bank of Canada announcement.
Here’s what low interest rates mean for you, small businesses and the Canadian economy.
What are interest rates anyway?
Interest is what consumers or institutions pay to borrow money. It is also the amount a bank can pay a customer to leave money in his account.
“When you take a loan, you’ll be given a cash amount and you’ll have to pay back that loan a little bit over time,” said Andrew DeCapua, chief economist at the Canadian Chamber of Commerce in Ottawa.
“That repayment includes some interest.”
Commercial banks such as RBC, Scotiabank, TD Bank, CIBC and BMO use “prime rates”, which are their starting rates, to charge consumers borrowing money. That rate is usually combined with a percentage that is calculated based on a person’s creditworthiness.
Those key rates are guided by the Bank of Canada’s overnight interest rate – a tool central banks use to keep inflation under control.
When inflation is running too high, the Bank of Canada may raise that benchmark rate to discourage people from borrowing (and spending) money.
For example, it could encourage someone buying a new car to “get a smaller car or a cheaper car” — or delay buying a car altogether, DeCapua said.
But when rates go down, it becomes cheaper to borrow money. And this often encourages people to spend more, which can lead to economic growth.
Low interest rates can mean different things to different parts of the economy. Because of that, the central bank balances potential growth against the risk of inflation when setting its benchmark rate.
How do interest rates affect the housing market?
Homeowners – especially those with variable rate mortgages – are among those who feel immediate relief when the Bank of Canada lowers their interest rates.
Their monthly mortgage payments will fluctuate depending on the rates.
Potential homeowners may also be encouraged to jump into the market when lenders offer lower variable rates, DeCapua said.
The lower benchmark rate can also help potential buyers lock in a low “fixed” mortgage rate that will not fluctuate with future interest rate changes.
September and October are usually weak months for the market, but this year’s rally remains surprising. The decision by the central bank of Canada to lower its key interest rate by 25 basis points last week is not so surprising. Foundation Wealth’s Mark Ting joins CBC’s Dan Burritt to break down what this means for those shopping for a mortgage.
That’s why lower interest rates can lead to more home sales, which in turn can impact the economy. When rates are low, “we often see a psychological shift among buyers,” said Penelope Graham, a mortgage expert at RateHub.ca.
“Taking that edge off with low interest rates often leads to more activity in the housing market, especially if people have a ‘if I don’t move now, I’ll miss out’ mentality,” he said.
How do interest rates affect small businesses?
Without the burden of higher housing-related down payments, consumers can spend more of their budget purchasing goods and services, and put their money to work in other parts of the economy.
“For example, those consumers may have more disposable income to buy more goods at retailers or more experiences at hospitality businesses,” said Simon Gaudreault, chief economist and vice-president of research at the Canadian Federation of Independent Business.
Central banks typically raise interest rates to keep prices in check during inflation, but the Bank of Canada and the US Federal Reserve have cut rates. Andrew Chang explains how Trump’s tariffs and a depressed job market led to the same inflection point for the countries’ dueling economies. Images provided by Getty Images, The Canadian Press and Reuters.
Also, small businesses can take out their own variable rate mortgages or other loans (such as a manufacturing company that borrowed money to purchase expensive equipment).
If the rate goes down, “it’s good news for (those) business owners,” Gaudreault said.
But even if the central bank continues to cut rates, low interest rates do not automatically give businesses a happy outlook.
The Bank of Canada recently asked businesses how they are feeling about the economy and the results were largely under controlEspecially in the context of the trade war which has turned uncertainty into the new normal.
As Gaudreault says, businesses are struggling with labor shortages and rising operating costs (such as insurance premiums), and the cost of resources has increased with inflation and tariffs.
“There is so much uncertainty right now, so much weakness in the economy that businesses have to be very careful about where to put their money,” Gaudreault said.
“There’s not much money for new investments or new hires. They keep their money to cover all those high operating costs.”
How do interest rates affect personal finance?
When it comes to personal loans — such as the car loan example from earlier — borrowing with prime rates will lower the cost of borrowing, said Shannon Lee Simmons, a Toronto-based certified financial planner and founder of the New School of Finance.
The cost of borrowing money from a credit card or line of credit can also be reduced through cheaper loan payments, Simmons said.
For example, if the cost of borrowing on a line of credit is high, a new homeowner may hold off on renovating. If rates go down, they can use a loan to finance that renovation.
But lower interest rates may be less welcomed by Canadians who are trying to save and grow their money because financial institutions will pay consumers less to keep their cash.
Receiving low interest payments from savings accounts and guaranteed investment certificates (GICs) can feel “frustrating,” said Simmons.
“But if you’re invested in the stock market and you have fixed income products like bonds – generally speaking, when interest rates go down, bond prices will go up. And so it really depends on your asset mix,” she said.
What else do I need to know about the rate cut?
DeCapua said, “The relationship between interest rates and prices depends on how fast or slow the economy is growing relative to its ability to produce goods and services.”
When demand exceeds supply — and the economy needs more workers, more capacity or more machinery than is available — it can lead to higher prices, he explained.
But any change in interest rates in the economy may take some time. According to DeCapua, the traditional view among economists is that these changes take about a year and a half.
“That’s because, of course, the lending rate affects the banks, the banks then change their rates and then those rates – the prime rates that the banks use – then flow through the system through different financial instruments and loans,” he said.
He said the Bank of Canada’s interest rate decisions are a clear signal to Canadians who want to know “where the economy is going.”
The signal could affect public confidence in the economy, which “could influence consumer behavior, influence business decision making,” DeCapua said.
“As I would say, it’s a kind of soft power that the Bank of Canada has.”
