The Bank of Canada just slashed its overnight rate again. It is now at 3.25% and the prime rate has dipped to 5.95%.
The recent hikes were an attempt to slow down the record 40-year-high inflation, but the interest rate hikes put even more pressure on Canadians. After much anticipation, however, the rate has now been cut. Here is what you need to know about how interest rate cuts affect you and your money.
Do Rising Interest Rates In Canada Affect My Mortgage and HELOC?
The interest rates set by the Bank of Canada, also known as the ‘bank rate’, is a key factor in determining the cost of borrowing money. The Bank’s job is to set this rate to mitigate the instability of current inflationary times and hopefully form a healthy and stable growth of the economy.
When interest rates rise, you may see an increase in monthly payments on your mortgage, line of credit, or other loans with variable interest rates. If you have a fixed rate on a loan, you likely will not see the effects of the interest rate hike until it is time to renew or refinance your mortgage and loans.
Mortgages
In Canada, the current prime rate for borrowing is currently 5.95%. The federal prime rate acts as the starting point for most other interest rates.
To calculate how much more you will be paying on a variable rate mortgage, let’s say you have a $600,000 mortgage with an interest rate of 5.95%, amortized over 20 years. Way back when you took out your variable rate mortgage, the prime rate was 3.7%. Your monthly payment for this on a 5-year term and 20-year amortization was $3,532.96.
With the new prime rate, you would be paying $4,256.31. That’s an additional $723.35 each month.
Learn about how inflation affects your mortgage.
Home Equity Lines Of Credit (HELOCs)
A HELOC is a line of credit that is collateralized with your home.
Those with HELOCs usually have a variable interest rate, making them susceptible to changes in interest rates. While this can be advantageous when interest rates are declining, it’s also expensive when interest rates rise. Given the overnight rate increased by 100 basis points, HELOCs might be risky as the required payment will continue to rise along with interest rates.
To get a better understanding of how much more you would repay, it would be an additional $1,000 of interest on every $100,000 owed on your HELOC per year when interest rates increase by 100 percentage points.
How Does Rising Interest Rates Affect Other Forms Of Credit?
The rate hike could have a significant impact on other interest rates in the economy. That includes the interest rates offered by financial institutions on loans, savings accounts and investment accounts. It is essentially the fee you pay for borrowing money.
Credit Cards
Historically, credit card companies have not raised their rates when the overnight rate is increased. Most credit cards have fixed interest rates that are typically around 19.99%. While the rate hike won’t directly affect your credit card’s interest, you can expect to see added indirect costs. An example of indirect fees which credit card companies may charge is transaction fees to businesses. Though indirect fees are more likely, you can’t rule out long-term changes, like an increase to your credit card’s APR.
Personal Lines of Credit
With the overnight interest rate jumping up again, those affected will mostly be individuals with variable rate debts on secured or unsecured lines of credit such as personal lines of credit, business lines of credit, and HELOCs. Canadians with these variable rate debts will experience higher minimum payments due to the rise in interest rates. When the prime rate goes up as a result of the overnight rate hike, it can significantly impact the total cost of your loan.
Auto Loans
While most auto loans have a fixed rate, lenders can offer auto loans with variable interest rates which fluctuate based on the economy’s condition.
With variable-rate auto loans, when interest rates rise, many borrowers refinance and extend their terms. In short, your payment amount might be the same but you’ll be paying more in the long run, as it takes longer to pay off. Moreover, your financial situation might change over time and unforeseen circumstances may lead to missed payments which leads to more financial penalties.
If you currently have a fixed-rate auto loan, you’re unlikely to feel the effects of the interest rate hikes unless you need to refinance or renegotiate your auto loan.
Debt Consolidation Loans
A debt consolidation loan allows you to take on a personal loan meant to settle numerous high-interest bills, such as credit card debts. The goal is to enable those who are indebted to save money and pay off their debt faster.
Loans for debt consolidation may have a fixed interest rate or a variable interest rate based on the prime rate. If your debt consolidation loan has a variable interest rate, you’ll see that your monthly payment increases when the prime rate rises. However, if you have a fixed rate, you won’t feel the effects of the change unless you refinance. Do note, that as the prime rate rises, anyone seeking a debt consolidation loan with a fixed rate will wind up paying more in interest compared to a borrower who took out a debt consolidation loan last year.
Student Loans
Student loans typically have a variable interest rate which is expressed as prime plus/minus a certain percentage. Like other variable loans, if you are still in the process of paying off your student loans you may find that you will be required to pay more interest on your monthly payment.
Much like auto loans and other lines of credit, your student loan may also require more time to pay back. To combat this, try to pay back more than just the required monthly minimum, as less debt means less interest to pay back. And if possible, look into paying off a small portion of your student loan while you’re still in school. Reducing the total amount you owe will not only help you pay off your student loan faster but it’ll cost you less in interest as well.
Why Does The Bank Of Canada Lower Or Raise Interest Rates?
To understand the Bank of Canada’s interest rate policy, first, we need to look at inflation. Inflation is a persistent increase in the cost of goods and services which decreases the consumer’s purchasing power. In general, gradual inflation helps keep the economy strong by influencing wage increases and spending. Typically, a rate of 1-3% inflation reflects a healthy and balanced economy.
When Does The Bank Of Canada Lower Interest Rates?
If the economy is struggling to grow or experiencing a shock, the Bank may lower interest rates in order to help boost economic activity. When the overnight interest rate falls, people and businesses pay less interest on new and existing loans and mortgages, leading to an increase in consumer spending.
Why Did The Bank Of Canada Increase Interest Rates?
Following the pandemic in Canada, heavy consumer spending was a big factor in keeping the economy up. However, if an economy is growing too quickly it can lead to high levels of inflation. Unfortunately, the credit binge seen post-pandemic during a time of global turmoil fuelled record-high inflation levels, currently at 3.3%. As a response the Bank of Canada raised the overnight rate, to make it more expensive for people and businesses to borrow money. This in turn reduces spending which helps curb inflation.
How Might Interest Rate Hikes Impact The Average Household
Canadian households are holding much more debt compared to their income than they were just a few decades ago. The ratio of debt-to-household income is about 180%, meaning that for every dollar of disposable income Canadians are making, they owe $1.80 in debt.
Not including mortgage debt, the average consumer in Canada currently holds about $21k in household consumer debt. According to Equifax, When you include mortgage debt, the average consumer debt in Canada rises to almost 150k for a two-person household.
With all this in mind, it’s easy to see how a rise in interest rates might affect Canadians who are already struggling to make ends meet. While those with variable debts are impacted immediately, those with fixed-rate debt are typically impacted at the end of the term when they need to refinance.
How To Manage Rising Interest Rates And Debt
In order to curb the stress of debt and rising interest rates, here are a few things you can do:
- Review Your Loan Terms – Taking the time to understand the terms, interest rate and repayment expectations of your loans can help you better manage your debts.
- Pay Down High-Interest Debt – Focus on paying down high-interest debt first. If you have no high-interest debts, try to pay down your variable-rate debt to avoid further increases in your borrowing costs. Lowering your debt will reduce the amount of interest you have to pay.
- Have Your “Financial House” In Order – Keep yourself up to date on your credit scores and budget. If you can save a few dollars each week or month, it can help protect you against unexpected expenses. That way, you won’t have to rely on any credit products.
FAQ About Interest Rate Hikes
Will the increase in interest rates affect my credit?
How does the bps affect your interest rates?
How does the bps affect inflation?
Conclusion
The rise in interest rates can be confusing to understand and difficult to cope with. Luckily, high-interest rates are not permanent and ultimately implemented to help cool inflation. For the time being, make sure you continue to do your research and maintain awareness of your debts, income and expenses. Focus on creating a feasible budget and repayment plan.
