The Bank of Canada made a supersized rate increase on July 13 – increasing its benchmark rate by a full percentage point in an effort to get consumer prices back under control.
On the same day, The Globe’s personal finance reporter, Erica Alini, hosted an Ask Me Anything on Reddit, answering questions about who is most affected by the rate hike, and what consumers can do to cushion the effects.
How will the interest rate hike impact Canadian households?
In the short term: Rising rates make borrowing more expensive for people who have debt with variable rates such as a variable-rate mortgage or a line of credit. That puts extra stress on family budgets when people are already contending with record-high inflation. In the longer term, the interest rate increases are supposed to bring inflation back down, which would benefit everyone’s budget.
A few more things: A mortgage with a variable rate is a mortgage whose interest rate usually moves up or down after movements in the Bank of Canada’s interest rate. So the big increase from the bank means a big increase for variable-rate mortgage holders.
That said, many variable-rate mortgages actually come with fixed payments. So the amount you pay every month (or every two weeks) doesn’t change, but the bank applies more of your payment toward the interest rather than toward the principal. This means you’re chipping away at your mortgage balance more slowly and it will take you longer to pay your mortgage off.
For lines of credit, rate increases usually mean larger payments. That could be a problem, for example, for someone who just financed a big home renovation with a line of credit. It’s also something to keep in mind for students who’ve been borrowing with a student line of credit.
Should I convert my variable rate mortgage to fixed?
Some pros of switching:
- Avoid the risk that your payment will swell beyond what you can afford (lenders can adjust up your payment even if you have a variable-rate with fixed payments if interest rates rise by a significant amount).
- Buy yourself peace of mind. Even if you can afford larger payments, for some people the uncertainty of a variable is just too much psychologically. And peace of mind matters.
- Don’t expect to get the most competitive fixed rate from your existing lender. If you ask to switch, they know they’ve got you.
- If you want to shop around, you’ll have to break your mortgage and pay a penalty of three months’ worth of interest. You’ll also have to re-qualify for the stress test; at this point you’re looking at having to qualify at around 7 per cent for a five-year fixed.
- Locking in now means locking in at very high rates historically. And breaking out of a fixed rate will be expensive because fixed-rate mortgages usually come with much stiffer penalties compared to variable-rate mortgages.
One thing to consider is the possibility of locking in for a shorter term: so a one-, two-, three-year fixed instead of a five-year term. But some lenders won’t let you lock into a fixed for a different term than the one you have.
Likewise, it’s possible it won’t be too long before we see rates decline again, especially if we head into a recession. If you stay in a variable rate you get to ride rates down.
How will increased housing costs impact Canadians?
The first thing to be cut is discretionary spending, so entertainment, travel, all that fun stuff, sadly. I also suspect these rate hikes are going to bust the reno boom pretty quickly. That said, despite the belt-tightening, a lot of people will probably continue to be okay as long as the labour market holds up. The biggest risk/worry is if we start to see broad layoffs and people lose their jobs. I’m really hoping that won’t happen.
Another thought: Many people may be able to continue to make ends meet for now even with enormous housing costs, as long as they have jobs. But if they have no wiggle room to save for an emergency fund or attack their debt more aggressively, then that leaves them that much more vulnerable if they do get laid off.
OK, so mortgages are impacted by Bank of Canada’s rate hikes. What else?
GICs are already looking pretty attractive, but it may not hurt to wait and see if they’re going to climb further after this latest hike if you can afford to wait. (I wouldn’t wait too long though – remember inflation is eating away at your savings fast if they’re just sitting in a bank account.)
Where’s the best place to invest as interest rates rise?
With inflation so high but savings accounts offering so little interest, should people be thinking differently about how they save or invest their money? Should we expect savings accounts to start to pay more interest?
I’ve been thoroughly unimpressed with how long it’s taking lenders to adjust rates on savings accounts. They were super quick to cut in the spring of 2020, but now I’ve seen one or two small increases at most – even at the online banks!
On the other hand, the rates of GICs, or guaranteed investment certificates, for some reason have been rising much faster. As my colleague Rob Carrick has pointed out, you can now get a 5-per-cent return on some five-year GICs.
For a long time, the most competitive high-interest savings accounts in Canada were offering rates that were higher than even five-year GICs – which meant there was little reason to lock away your money for years. But now that has changed. A 5-per-cent return is still below the latest inflation reading (7.7 per cent) but it’s still pretty good, in my opinion, for a very safe investment at a time when the stock market is in a rut anyways. Not to mention that 5 per cent may look really good in a few years if interest rates go back down.
Why did the Bank of Canada increase its interest rate?
Is there an idea to why the Bank of Canada did this? There has to be a reason and maybe even some benefit for this type of hike.
Yes, the Bank of Canada (and a bunch of other central banks around the world who are facing the same problem) are doing this to slow down inflation (the pace at which prices are increasing). Increasing interest rates make it more expensive for consumers and businesses to borrow (and more attractive to save), which slows down economic activity. When that happens, businesses become more cautious about increasing prices.
The trick right now is that a lot of the high prices we’re seeing are due to factors that the Bank of Canada has no control over, such as Russia’s invasion of Ukraine (which affected the cost of grains and energy, for example) and lingering supply-chain snags that make it more expensive to get goods from places such as China.
That said, there is a growing consensus among economists that the current bout of inflation is also in large part tied to the fact that Canadians have money to spend and are in the mood for spending (lots of people were lucky to be able to save up during the pandemic, and now they want to have fun). So rising interest rates should have some impact at least on the domestic-spending side of things.
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