Maciej Korzekwa
The Bank of Canada delivered a sobering warning on Thursday, reminding us that low interest rates won't last forever. Household debt that is easy to service now could become a much heavier burden for families in the future.
"Households need to assess their ability to service these debt obligations over their entire maturity, taking into account likely changes in both income and interest rates,"' the bank told us.
In the corporate world, there has been a high level of refinancing activity over the past year as companies position their balance sheets more securely for an uncertain future.
Although the central bank has not yet moved away from its stance on keeping interest rates low, it makes sense for families to consider and prepare for a higher interest rate environment as well. In order words, think about how higher interest rates could affect your ability to manage your debt and try to reduce any potential risk of a default now.
. Weigh in on whether you would stash some extra money into an RRSP, RESP or a TFSA.
In my own home, we recently refinanced our largest debt obligation - our mortgage. With nearly three years to go on our five-year fixed rate mortgage, the penalty was too high to break the agreement and move to a lower interest variable rate. However, my husband and I were concerned about having to refinance our mortgage in 2012, when interest rates may be significantly higher than they are now.
Future interest rates are impossible to predict, driven as they are by a multitude of variables. But we could at least manage our risk exposure. We decided to blend and extend our existing mortgage. This means we blended the interest rate we were paying on our mortgage with the current rate, shaving off 50 basis points, and committed to another five years at the new fixed rate.
Only time will tell whether this was the right move or not. We may well be sorry to have locked into another fixed rate mortgage if rates are still low three years hence. But we have bought peace of mind, knowing that we can comfortably afford our mortgage payments at these levels.
The interest rates on lines of credit and personal loans from bank will also be affected if the central bank moves to raise the prime lending rate.
Personal lines of credit are enormously popular with Canadians. At the end of 2008 personal lines of credit represented 57 per cent of consumer credit issued by chartered banks, according to a report from the Certified General Accountants Association of Canada.
While many of us use our lines of credit as revolving facilities, personal finance experts recommend keeping the balance as low as possible.
"With interest rates low today, now is the time to get rid of the line of credit and pay down chunks of it," says Laurie Campbell, executive director of Credit Canada, a non-profit credit counseling agency.
If you are carrying a credit card debt, with interest rates that can range anywhere from 18 to 28 per cent, consolidating that debt on a line of credit with a lower interest rate does make sense. Still, says Ms. Campbell, "Always have a plan of attack as to how to get rid of it."
Many of use are also using home equity lines of credit (HELOCs) as a mortgage alternative. These lines of credit are typically secured against your residence and carry a lower rate of interest than a non-secured line of credit. These too, however, will fluctuate with the prime rate.
The best way to manage your debt for a world with higher interest rates is simply to have less of it. It's not rocket science, but it takes focus and preparation to get your family's balance sheet in shape. The time to start is now.