January 19, 2018 4 minute read
After nearly a decade of sustained and almost historic low interest rates, Canadians were surprised (to say the least) when in a moment of weakness the Bank of Canada (BoC) introduced the third interest rate increase since July 2017 to 1.25%.
Canadians are already over extended by record levels of debt, and we’re not just talking about our government — these moves will surely put an unexpected and hefty dent in hundreds of thousands of budgets. With this rise and the carbon tax introduced just a few weeks ago, its easy to wonder how you will keep up with these additional costs.
In order for you to avoid impending rising debt, you need to understand how the rising interest rates could affect you. Here’s some points we hope help!
Bank of Canada Overnight Rate
The purpose of the BoC’s overnight interest rate is to dictate the cost for major financial institutions to borrow and lend money amongst themselves — it influences the rates banks charge their customers for the various loans, mortgages, credit cards and lines of credit they take out.
What’s important to note is that the policy rate does not directly translate to interest rates charged to the public by banks and other lenders. These rates are higher to allow creditors to profit from their lending activities… yay banks.
Therefore, when the BoC increases its overnight rate, the increase for consumers will also be slightly higher.
Fixed or Variable Rate?
You may or may not see the immediate consequences with the rise in rates. There’s a few things to consider:
- If you are carrying fixed rates on your mortgage, loans or lines of credit, it’s likely that your interest rate will stay the same for the period of your fixed term.
- If you renew your term, the new rate will be influenced by the current rate at that time.
- If you are carrying variable rates on any debt, your interest rate will increase immediately.
How Interest Rate Increases Will Affect Your Debt
The affects depend on several factors, such as:
- The type of debt you have (fixed or variable),
- How many debts you own,
- How much debt you are carrying, and
- If (and how much) you are currently contributing to the principal value.
Mortgages depend on whether you on a fixed term or variable rate. You will need to consider how long you have until it’s time to renew and if you’ll be able to afford the principal payments. Do you have room in your budget, and how much of an increase could you handle? Figure out a good time to lock your rate in so you prevent further cost increases!
Lines of Credit / Home Equity Lines of Credit are usually on a variable rate, so the affects of increases will be similar to those of a variable rate mortgage. It’s important to remember, though, that unlike a variable rate mortgage, you may not have the option to lock your rate in.
This leaves you with one option: pay down the principal value of your debt.
Credit Cards mostly use a fixed interest rate so you shouldn’t see much of a change. However, be aware: issuers reserve the right to raise interest rates at their discretion and can do so without you ever having missed a payment. Keep an eye on your statements for any rate changes.
How to Cope with Rising Interest Rates
It’s simple: the more debt you have, the more expensive these rate increases will be for you. The best thing you can do for yourself? Pay down your debt as quickly as possible!
Here’s some steps to consider:
- Cutting expenses wherever possible.
- Pay down debts with the highest interest rate first, continue to make the minimum payments on lower interest rate debts.
- Find ways to increase your income.
- Apply for a consolidation loan for your high interest rate debts. This will allow you to pay the balance down faster while making the same payments.
- Avoid taking on the largest value mortgage, loan or line of credit you are offered. Budget what you can afford, take into account another possible raise in rates.
- Reconsider borrowing, think about how it might affect your financial freedom.
- Regularly contribute to an emergency fund.
If you’re worried how this might affect your finances or current loans/lines of credit, reach out to one of our professional chartered accountants. We’re here to ensure you succeed in all aspects of your life, finances is just one of them!