It’s been hard to avoid the recent headlines about rising inflation and interest rate hikes. Inflation reached 8.1% on July 20, 2022, the highest level for 39 years, and rates have increased 2.25% since March. Many economists predict more rate increases in 2022 as the Bank of Canada (BoC) tries to rein in inflation. Let’s look at what this might mean for you and review a few things you can do.
Left unchecked, inflation—a rise in consumer prices over a period of time—can hit people’s pockets, and the economy as a whole, hard. One lever the BoC has to bring down inflation is raising interest rates. This can slow down the economy and stop people from borrowing money they may struggle to pay back. Higher interest rates also encourage people to save more and spend less, prompting companies to slow down or stop price increases—or even reduce prices.
Financial institutions use the BoC interest rate to set their “prime rate”—the lowest interest rate they will charge borrowers or offer to savers. So, when the BoC raises interest rates, the cost of borrowing money through a new mortgage, line of credit, or other loan goes up.
Here are some things you can do, depending on your financial situation:
With a variable rate mortgage, if interest rates rise but your fixed monthly mortgage payments stay the same, you will pay more in interest each month and less toward paying off your principal amount. This means it could take longer to pay off your mortgage and the amount of interest you’ll pay over the life of your mortgage will be significantly higher. You have a couple of options:
|Prime Increase Impact||Mortgage*||Scenario 1||Scenario 2|
Variable Interest RateMortgage Payment
*Based on a $500,000, 5-year variable closed rate mortgage as of June 27, 2022, with a 25-year amortization. Blended payments monthly.
With a variable rate line of credit, higher interest rates means it costs you more to borrow money. Consider paying off as much as you can now and cutting back on how much you borrow through your line of credit.
If you are house-hunting or looking to refinance a mortgage, higher interest rates may reduce how much you can borrow. Consider staying ahead of future interest rate rises by getting pre-approved at a specific rate. You can lock into that rate for up to 120 days before you buy. If rates rise, you can still borrow at the lower rate your lender pre-approved you for.
It’s not all doom and gloom. You can earn more interest in a savings product, such as a term deposit / GIC, RRSP or TFSA. Consider increasing how much you save each month to take advantage of better returns and grow your money.
While a 0.25% or 0.5% increase might seem small, it can lead to hundreds of dollars a month more in mortgage or line of credit repayments.
Take house hunters, for example. Buying a house for $600,000 with a 10 per cent down payment and 25-year amortization period requires a $556,740 mortgage. If you can lock into a mortgage rate of 5 per cent, your repayments would be $3,238 a month when you buy. If you wait too long and rates rise by 2 per cent, your monthly mortgage repayments would be $3,899.
Whatever your financial situation, talking to a financial advisor can help you navigate your options and make informed decisions.