Tiff Macklem. Jerome Powell. Donald Trump. Lots of names come to mind when we think abut what causes interest rates to move up and down. But the actual dynamics reach much deeper than these people in positions of power. Canada's system is particularly unique among G7 nations. Here's everything you didn't - but should - know about it:
What Is Interest?
Interest is the cost paid for borrowing money or the reward earned for lending or depositing money, usually expressed as a percentage of the amount borrowed or invested. There are two main types: simple interest, which is charged only on the principal for each period., and compound interest, which is based on the principal plus any previous interest accrued.
Where It Matters Most: Your Mortgage
Interest rates affect so many aspects of life, because they essentially determine how accessible additional funds are when you don't have enough on hand. The cost of borrowing money from a bank – whether for a large purchase like that of a new home or everyday bill –- changes with fluctuations in rates.
While there's no formal rule for financial institutions to follow when setting mortgage rates, most tend to base their decisions on the Bank of Canada's overnight rate as a benchmark, adding their own margin to account for risk, operational costs, and profit. This means that when the central bank raises or lowers its key rate, mortgage rates typically move in the same direction, though not always by the same amount.
For Canadian homeowners, this relationship is particularly important because most mortgages are renewed every five years or less. Unlike in the United States, where 30-year fixed mortgages are common, Canadian borrowers face regular rate resets that directly expose them to the central bank's monetary policy decisions. A single percentage point increase in rates can add hundreds of dollars to monthly mortgage payments, making the Bank of Canada's rate announcements some of the most closely watched economic events for millions of households.
How the Bank of Canada Sets Interest Rates
The Bank influences short-term rates by adjusting the target for the overnight rate—the interest rate at which major financial institutions lend or borrow funds from each other for one day. This rate is announced on eight pre-scheduled dates throughout the year, determined by the Bank's Governing Council after consulting internal and external economic data and forecasts. Their decision can also be made outside of the regular schedule during economic emergencies.
Who Decides and How
The Governing Council (consisting of the Governor, Senior Deputy Governor, and Deputy Governors) makes the final interest rate decisions, supported by economic analysis from committees and research groups. They consider economic signals like Statistics Canada data, business and consumer surveys, forecasts from other institutions, and market expectations.
Why Rates Change
The overnight rate indirectly affects all lending and borrowing rates in the economy, including the prime rate for mortgages and savings products. If borrowing costs are high, both businesses and individuals tend to hit pause on big financial commitments. That's why we often see the bank issue rate increases during periods of economic inflation. Interest rates can also be lowered to encourage borrowing and spending and stimulate growth.
How Long It Takes Mortgage Rates to Affect Real Estate
With real estate being one of, if not the biggest financial decisions most Canadians will make, understanding the timeline between rate changes and market effects is crucial. The impact isn't immediate; there's typically a lag of several months before rate adjustments fully translate into observable changes in housing market activity.
Immediate Effects (0-3 months): Buyer sentiment shifts almost instantly when the Bank of Canada announces rate changes. Potential homebuyers may rush to secure pre-approvals before anticipated increases, or pause their search if rates have risen significantly. Real estate agents often report changes in showing activity within weeks of major rate announcements.
Short-term Effects (3-6 months): This is when the mathematical reality of buying power sets in. A buyer who could afford a $600,000 home at 3% interest might only qualify for $500,000 at 5%. Sales volumes typically decline as fewer buyers can meet affordability thresholds, while sellers may resist lowering prices initially.
Medium-term Effects (6-12 months): Price adjustments become more apparent as market realities force both buyers and sellers to recalibrate expectations. Properties may stay on the market longer, and sellers become more willing to negotiate or reduce asking prices.
Long-term Effects (1+ years): Sustained rate changes can fundamentally alter market dynamics, affecting everything from new construction starts to rental demand as potential buyers shift to renting instead.
Can You Time Interest Rate Changes as a Real Estate Investor?
Economists LOVE speculating over the direction of interest rates. You'll often hear predictions throughout the year. News, politics, and even expectations themselves come into play. It's not uncommon for any of those aforementioned factors to change, and with them, borrowing costs.
So no, you can't really time interest rate changes with any degree of certainty. Even professional economists and financial analysts frequently get their predictions wrong, and the Bank of Canada itself sometimes surprises markets with unexpected moves.
What you can do instead is build a strategy that accounts for rate volatility. This means stress-testing your investments at higher interest rates, maintaining adequate cash reserves, and avoiding over-leveraging your portfolio. Smart real estate investors focus on properties that generate positive cash flow even if rates rise by 1-2 percentage points, rather than trying to predict exactly when the next rate cut or hike will occur.
The most successful approach is to buy quality properties in strong markets when you find good deals, regardless of where rates currently sit. Interest rates are just one factor in real estate success. Location, property condition, rental demand, and your own financial position matter just as much, if not more.
