Two years ago, at the outset of the pandemic, the Bank of Canada aggressively dropped the overnight lending rate to battle the economic impact of COVID. The Bank signaled that it would begin raising interest rates once there was comfort that the worst of the economic storm had passed. Since then, Canada and the rest of the world have seen an incredible amount of support programs, spending and other government intervention. Many Canadians are rebuilding their lives after months of lockdowns. Though there are signs of economic recovery, fears of inflation and a risk of an overheated economy are rising once more. That is why the Bank of Canada has increased rates to 0.5%. So what does this mean for you? Long story short: loans are going to be more expensive to maintain, but returns on high-interest saving programs will improve.
What is interest and how does it affect me?
You can think of interest as the charge your lender applies for the privilege of borrowing money. Interest is expressed as a set percentage of the outstanding amount – also known as the principal – that you owe your lender.
How is my interest rate calculated?
The interest borrowers are charged is usually quoted as the annual percentage rate. The Bank of Canada sets a base rate; other Canadian financially institutions – including banks and credit unions– then choose whether to adjust their rates accordingly. When the Bank of Canada raises or lowers interest rates, so too do the rates offered by Canadian financial institutions. The Bank of Canada periodically raises interest rates to offset inflation, in which prices rise and affordability declines. The Bank of Canada sometimes lowers interest rates, in order to boost lending and economic activity.
It is crucial to understand why interest is charged as a percentage rather than a set amount. If your lender was simply looking to earn money from lending funds, charging a set fee for the service would be appropriate. But the lender also has to consider the likelihood that the funds being borrowed might not be paid back. Therefore the interest rate lenders charge borrowers varies depending on how risky the loan is considered.
How will rising interest rates impact my loans?
The most immediate impact from rising interest rates can be seen in any variable rate product such as a line of credit or a mortgage. For someone who owes $100,000 on one of these products, a 25 basis point increase in interest rates translates to a $250 annual increase in borrowing costs.
With forecasts ranging from 50 to 150 basis points expected increases over the next 18 months that same borrower could face $40 to $120 increase in monthly interest charges. For the borrower, that means either coming up with additional funds every month, or in the case of a mortgage not paying down your principle as quickly as you would at lower interest rates.
*This is just an interest calculation that does not include principal payments
How will this affect my everyday accounts and how can I prepare?
Here are some basic tips for adjusting to the interest rate increase:
- Take some time to review the types of accounts you have, and how they fit into your overall financial plan.
- Make sure you understand how your line of credit or mortgage works.
- Be prepared to pay more than your currently monthly amount on your line of credit going forward.
In short, you will need to begin budgeting and preparing to pay more on credit cards, lines of credit, and loans.
Feeling gloomy about these changes? Don’t worry. You can also expect some good news. Savings accounts will begin offering more attractive interest rates, making low-risk and guaranteed investing strategies potentially more appealing for your financial plans.
How will this affect my mortgage and how can I prepare?
Mortgages are especially vulnerable to interest rate increases. Their large outstanding balances ensure that even minor changes to rates can amount to significant differences in principal and interest payments.
By doing the following, you can feel confident that changes to your mortgage rate won’t interfere with your long-term financial plans:
- If you have a variable rate mortgage, consider increasing your payments. As interest rates climb, less is paid towards the principal, and more towards the interest, on variable rate mortgages. Left unchecked, rate increases can leave you owing more at the end of your mortgage term than you initially intended. You can make sure this doesn’t happen to you, either by increasing your monthly payments, or by switching into a fixed-rate alternative.
- Consider the benefits of a fixed-rate mortgage. They offer consistent interest rates that will remain unchanged for the duration of the term, and peace of mind from knowing that big market movements won’t upset your homeownership plans.
We’re here to help.
If you’re still unclear what this could all mean for you, connect with one of our advisors. We’re on standby to help you make sense of these rate hikes and feel confident about your finances. Call us at 1.888.517.7000 or book an appointment online.
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This article is provided for general information purposes only. It is not to be relied upon as financial, tax, or investment advice or guarantees about the future, nor should it be considered a recommendation to buy or sell. Information contained in this article, including information relating to interest rates, market conditions, tax rules, fees, and other investment factors are subject to change without notice, and Coast Capital Savings Federal Credit Union is not responsible for updating this information. All third-party sources are believed to be accurate and reliable as of the date of publication and Coast Capital Savings Federal Credit Union does not guarantee the accuracy or reliability of such sources. Readers should consult their own professional advisor for specific financial, investment, and/or tax advice tailored to their needs to ensure that individual circumstances are considered properly and action is taken based on the latest available information.
