Interest rate changes can have significant effects on the average consumer, with rate hikes triggering immediate changes to debt costs and payment requirements. Read on to learn what Canadian consumers should understand about interest rates, including how they can impact you and your finances – and what you can do to deal with your debt if you’re feeling financially stretched.
What is the Bank of Canada, and What Do They Do?
The Bank of Canada is the country’s central bank; it is a special type of Crown corporation belonging to the federal government that exists “to regulate credit and currency in the best interest of the economic life of the nation” with their primary role being “to promote the economic and financial welfare of Canada”.
Monetary policy is a core Bank of Canada function, and two main instruments used in this are its inflation-control target and the key policy rate:
- Inflation is the persistent rise in average price levels over time, and the Bank of Canada aims to maintain a stable price environment – a low, stable, predictable inflation is their goal. With price stability and low inflation, prices change so slowly there’s no major effect to how people spend, save, or invest.
- The Bank of Canada adjusts its key policy interest rate up or down as needed to achieve its inflation target. Doing so influences financial institutions’ interest rates, borrowing and spending, and pressure on prices.
What Does the Bank of Canada’s Interest Rate Mean for Other Banks?
Financial institutions borrow from each other and can also use the Bank of Canada, and by setting their policy rate the Bank of Canada encourages financial institutions to borrow and lend amongst themselves near the policy interest rate too. What this means is that although the public doesn’t borrow with the Bank of Canada, their policy rate affects interest rates on products such as:
- The prime rate for loans and lines of credit
- Mortgage rates
- Interest on savings and deposits
When the Bank of Canada changes their rate, lenders will generally adjust their prime rates shortly after.
- Prime rate is the annual interest rate our major banks and financial institutions use to set their interest rates for variable credit products, including loans, lines of credit and mortgages with a variable rate.
How Interest Rate Increases Impact Common Consumer Credit Products
Depending on which products (types of debts) you have, and whether your debts have fixed or variable interest rates, the impact of an interest rate increase can vary widely, from very significant to having no impact at all.
- When you have a fixed-rate debt you agree to pay the same interest rate over the course of your repayment term, regardless of shifts in the economic market.
- One benefit with this type of borrowing is that you’ve got stability in paying the same interest rate (until you need to renew, such as with a mortgage at the end of a set term).
- With variable interest rates, as the prime rate goes up or down, so does the interest you’re being charged on your debt. When you apply for credit with a variable interest rate the lender will offer you an annual interest rate tied to the bank’s prime rate.
Below is a breakdown of different types of common consumer debts, and how they may be impacted (or not) by interest rate changes:
The biggest impact of interest rate increases is likely to be felt by homeowners who are carrying variable interest rate mortgages.
- On a variable rate mortgage, quite simply, most payments will see an increase because of rate hikes. Most banks adjust quite quickly – people might see the impact even by the next month.
- Just a small interest rate hike can be very impactful. For someone with a variable mortgage of 2-3%, even a 1% increase in interest rates can translate up to a 50% increase in the interest being charged on the mortgage.
Conversely, on a fixed rate mortgage, your payments will not increase as you have ‘locked in’ the rate you will be charged over the term of the mortgage. At renewal time however, you can expect that the rates you locked in at previously may no longer be available and your new interest rate upon renewal could be significantly higher.
Lines of Credit and Home Equity Loans
Most lines of credit (whether secured against your home or not) are offered with a variable rate, which means there is a direct impact of an interest rate increase.
- Higher payments will be required immediately, and this can be very significant – especially if you are financially stretched and are capable of paying just interest only on your line of credit.
Most vehicle loans are structured with a fixed interest rate, meaning that payments wouldn’t change at all.
Although an interest rate hike won’t cause a direct increase on your monthly vehicle financing payment with a fixed interest rate, individuals with vehicle financing should be aware that:
- If you decide to trade-in your vehicle before the end of your financing contract, you may absorb the ‘negative equity’ (i.e., the value of your vehicle, less the amount you still have to pay on the original loan contract).
- New loans applied for following an interest rate hike will most likely have higher interest rates, and as a result will come with an increased cost to borrow.
If you do have a vehicle financing contract with a variable interest rate component, normally a rate-hike will mean extending the time you’ll make payments so that the additional interest rate costs are paid.
If you have a fixed-rate student loan you won’t be impacted with increases in your interest rate or monthly payments, but following increases in prime rates, future student loans can become more expensive.
However, if your student financing is using variable rates, both your interest rate and minimum payments will increase with interest rate hikes.
Are Credit Cards Impacted by Interest Rate Changes?
Most credit card terms are set without regard for prime interest rates and if your only debt is on credit cards then your monthly payment requirements are unlikely to be impacted by an interest rate increase.
With standard credit card interest rates hovering near 20%, the very real danger of interest when it comes to credit card debt is that the interest charged is always expensive, regardless of fluctuations in the Bank of Canada rate.
- If you’re not paying off your credit card in full each month you accrue interest charges – a cost of borrowing – and then only a portion of your payment goes towards paying down the amount you actually charged on the card.
- In some cases, just $10 of what you pay each month goes to reduce the balance; the remainder covers interest and finance charges that reoccur each month.
- Check your monthly credit card statement to see a breakdown of how long it will take you to pay off your credit card balance if you only pay the minimum payments each month. The number might surprise you!
- If you miss a payment, you could find your bank raises your credit card interest rate because of the ‘delinquency’. Increases of up to 5-10% are not unheard of.
What Can I Do About Rising Interest Rates?
The single biggest and best thing you can do to prevent or mitigate being impacted by interest rate increases is to pay down as much of your debt as possible – and even if you’re mainly carrying debts not likely to be impacted by rate hikes, the sooner you get out of debt the better.
- Calculate your “Rule of 60 Math”: Add up your total (non-mortgage) debt then divide that number by 60.
- Is that figure a monthly payment you could afford to pay so that you’ll have your debt paid off in five years (60 months)?
- If that hypothetical payment is not affordable for you, or you think it would be difficult to consistently manage, connect with a Licensed Insolvency Trustee about your options for dealing with debt – especially if you’re already in (or are approaching) a position of being over-extended.
- If you’re a mortgage holder, you may want to research options for locking in your mortgage to a fixed rate. Though often more expensive in the long-term, a fixed rate mortgage can give you certainty for your budget.
- Be sure to shop around for the best rates and consider using a mortgage broker.
- Proceed with caution if you’re considering restructuring your debts with consolidation loans or balance transfers – it’s important to fully understand the full costs of borrowing before signing any documents.
- If your credit history has been impacted by an unfavourable debt to income ratio you may find it difficult to qualify for a line of credit or consolidation loan at a low interest rate, or at all.
- Make sure you can realistically stick to the budget needed to get your debt paid off and are not simply delaying an inevitable cash-crunch.
Consolidate and Cut Your Debt – Without Borrowing
Although you might consider a new loan or line of credit, a Consumer Proposal provides a welcome alternative to consolidate your debt without turning to more borrowing and paying interest charges:
- A Consumer Proposal allows you to pay off your consolidated debts without any further interest charges, and your creditors will agree to accept repayment of typically as little as 20-50% of your balance due, in full settlement of your accounts.
- Virtually all types of debts can be consolidated and reduced with a Consumer Proposal – from credit cards to lines of credit, overdrafts, income tax debt, CERB overpayments, student loans and more.
- Your credit history or credit score are not factors for eligibility, and no co-signer is needed.
- You can pay off a Consumer Proposal early at any time without penalty.
Licensed Insolvency Trustee Blair Mantin Talks Interest Rates and Debt Solutions
Sands & Associates President and Licensed Insolvency Trustee Blair Mantin joined Global News and Breakfast Television Vancouver to discuss what Canadian consumers should know about interest rates and debts, including what you can do to deal with problem debt. Watch the clips here:
Sands & Associates’ local office network serves communities across BC, and our full suite of debt help services is available online, by phone, or in-person. Connect today at no cost to discuss your situation and learn about your options.