Higher interest rates can affect the cost of borrowing, investment performance and savings rates. To help you make sense of Canada’s rising rates, we’ve compiled this short guide.
Canada is now moving through a phase of increasing interest rates as the Bank of Canada (BoC) manages higher inflation and other factors in the economy. Since the interest rate rose at the beginning of March 2022 — the first time in four years — the changes have begun to impact Canadian households in a variety of ways. Some of them may surprise you.
During the initial phase of the COVID-19 pandemic, the BoC dropped its interest rate to 0.25% to support the Canadian economy in the face of sudden economic uncertainty and market volatility. While maintaining this rate throughout 2020 and 2021 allowed borrowers some relief in the form of less interest paid, it may also have contributed to a scorching housing market and rising inflation.
“Debt is like fuel,” says Alex J. Lee, a High Net Worth Planner with Wealth Advisory Services, TD Wealth. “It can really help accelerate the increase in your wealth, but it can also accelerate your losses. Interest rates play a big role.”
If you have a mortgage, consumer debt or are feeling a little stretched financially, take heed. As we enter a new phase of rising rates, here are some ways you may be affected.
Mortgage rates are often the first thing people think about once a rate hike has been announced. For both prospective buyers and existing homeowners, even a slight increase can have a significant impact over time. If you currently have a fixed-rate mortgage, you won’t feel the change right away. You’re still locked into the interest rate you negotiated at the beginning of your mortgage term and that rate won’t change until the term ends and it’s time to renew.
If you have a variable rate mortgage, you could notice the change in a matter of days or weeks. Depending on your agreement, however, your monthly payments may not change. Instead, more of your payment will go towards interest, which can mean it may take longer for you to pay back your loan.
“If you’re actively using debt to finance your real estate investments, you may want to be cautious as these rate hikes take effect. You could find yourself overleveraged,” says Lee.
Homeowners who have used their homes to secure a loan via a Home Equity Line of Credit (HELOC) may also be impacted. If you have a HELOC, you might want to revisit your terms and ensure your debt load is still reasonable.
Student loans are also affected when interest rates rise. Anyone who is still paying off student loans may see their monthly payments increase. Additionally, if you purchased a new car prior to the rate hike, your car payments could be similarly affected. Like a mortgage, auto financing is based on either a fixed or variable interest rate. If you signed up for the latter, your monthly car payments may increase.
Not all is doom and gloom, however. As interest rates rise, we also begin to see an increase in savings. Guaranteed Investment Certificates (GICs) are perhaps the most obvious example of this. When interest rates were low, so were the rates being offered for savings accounts and investments. Lee says that the rise of GIC interest rates can be particularly beneficial for investors who may be more risk averse. “Coupled with high inflation, low returns on GICs have been really tough on some people. Rising interest rates, therefore, can be pretty beneficial,” he says.
Bonds are another type of investment affected by an increase in interest rates. As interest rates rise, bond yields tend to go up. To stabilize the yield value between bonds purchased before the hike and those purchased after, the price of the bond goes down. Keep in mind, many other day-to-day factors influence the price and yield of a bond outside of interest rates.
Inflation measures how much the price for goods and services is rising, and it can be affected by a number of variables — including interest rates. When interest rates are very low, people tend to borrow and spend more which can disrupt the balance between supply and demand. When interest rates are higher, people tend to save more and spend less. Increasing the interest rate can therefore work to rebalance the economy, although it may also slow business activity for a period of time as both business and personal loans are impacted when rates rise.
At the beginning of the pandemic, interest rates were lowered to stimulate economic growth in the face of uncertainty. Now that economic growth is somewhat overstimulated, the BoC has signalled it’s time to decrease that stimulation. That can have the ability to cool inflation in Canada but there are many other factors internally and externally that can still work to keep pushing inflation higher.
As we begin to leave a very low interest rate environment, Lee recommends caution: “Be careful with real estate purchases and leveraged investing in the months ahead. You might find yourself in a position where the cost of borrowing has gone up and the asset you purchased might be worth less. You don’t want to take a hit on both ends.”
Canadians are dealing with a lot right now. In the last two years, we’ve had to manage a worldwide pandemic, inflation and ongoing geopolitical uncertainty. Higher interest rates may feel like an additional burden. If you need help building a plan that addresses your financial concerns, a wealth professional may be able to help.