Who decides interest rates in Canada?

No single actor. The Bank of Canada sets the policy rate, commercial banks set prime and their own product rates on top of it, and bond markets set longer-term rates such as those behind fixed mortgages. Your personal rate is then adjusted for the product type and your credit profile.

Why do savings accounts pay less than loans charge?

The gap is the bank's spread, which covers its costs, its losses from borrowers who default, and its profit. Both rates move with the policy rate, but the spread between them rarely closes.

Is a lower interest rate always the better deal?

Not automatically. Rates can be quoted with different compounding frequencies, and loans can carry fees that a bare rate hides. Compare effective annual rates and total cost over the same period, not just the advertised number.

Interest

Intérêt in French

Quick definition

Interest is the price of money: what a borrower pays to use someone else's funds, and what a saver earns for lending theirs. It is quoted as an annual percentage of the amount borrowed or deposited.

The price of money, seen from both sides

Every interest rate is a rental price. When you take out a mortgage, a car loan, or carry a credit card balance, you are renting money and the interest is the rent you pay. When you put money in a savings account or a GIC, the bank is renting your money, and the interest is the rent it pays you.

Banks live in the gap between the two. They pay savers one rate, charge borrowers a higher one, and keep the difference, called the spread. That is why the rate on your savings account is always lower than the rate on your loan, even at the same institution.

How rates are set in Canada

Canadian interest rates are built in layers. At the bottom sits the bank of canada policy rate, the rate at which major banks lend to each other overnight; it anchors the cost of money for the whole economy. On top of it, each bank sets its prime rate, typically a couple of percentage points above the policy rate, which serves as the reference for variable-rate mortgages, lines of credit, and many loans. Your own rate then adds a risk premium: a markup that depends on the product you are borrowing with and on how likely the lender thinks you are to repay, which is largely read from your credit score. When the policy rate moves, the whole stack tends to move with it.

Simple interest

Simple interest is calculated on the original amount only. Lend $1,000 at 5% simple interest and you earn $50 a year, every year, with no acceleration. It shows up in some short-term lending, bond interest accrual between payments, and promotional financing, but it is the exception rather than the rule.

Compound interest

Compound interest is calculated on the original amount plus all the interest already added to it, so the balance grows faster the longer it runs. Almost everything that matters in personal finance compounds: savings accounts, GICs, investment returns, mortgages, and credit card balances. It works for you when you save and against you when you owe.

Fixed vs. variable

A fixed rate is locked for the length of your contract, so your cost is predictable no matter what the Bank of Canada does. A variable rate floats with prime: it falls when rates fall and rises when they rise. Fixed buys certainty, variable buys the chance of paying less, and the right choice depends on how much rate risk your budget can absorb.

Why one person pays 5% and 21% at the same time

The same borrower can hold a mortgage near 5% and a credit card near 21%, and the difference is not the person, it is the security. A mortgage is backed by a house the lender can seize and sell if payments stop, so the risk premium is small. A credit card is backed by nothing but a promise, so the lender prices in the losses from borrowers who never repay. The less collateral behind a debt, the higher its rate: secured mortgage, then car loan, then personal loan, then credit card, roughly in that order.

In Canada

In Canada, the Bank of Canada announces its policy rate on eight fixed dates a year, and the big banks usually adjust prime within days. That single decision ripples into variable mortgage payments, line of credit costs, savings account rates, and GIC offers across the country, which is why announcement days make headlines.

Interest you earn is taxable as ordinary income in a regular account, but grows tax-free in a TFSA and tax-deferred in an RRSP. Interest you pay is generally not deductible for personal borrowing, with narrow exceptions such as money borrowed to invest.

Worked example

Nadia has $8,000 in a savings account earning 2%, a mortgage at 5%, and a credit card balance of $3,000 at 21%. Her savings earn about $160 a year while the card costs about $630 a year. Using most of the savings to clear the card trades a 2% return for the elimination of a 21% cost, improving her position by roughly $470 a year with zero risk. The price of money is the common ruler that makes that comparison possible.