In our previous post we provided context on how the Bank of Canada (BoC) uses interest rates to manage economic growth and inflation. We also examined why rates are at historically low levels, and why this has lead to a high debt burden for many Canadians.
Our second post provides tips on what you can do to protect yourself if rates continue to rise.
What should you do?
Reduce your debt
Variable rate loans will quickly be impacted by higher rates. Business loans, variable mortgages, lines of credit, student loans and home equity lines of credit (HELOC) are usually tied to variable rates.
The below chart shows how interest rate changes can cost you more in monthly mortgage payments. This assumes a $278,748 mortgage with 23 year amortization at a current 3.1% rate.
In this example a 1% increase in interest rates actually increased the monthly payments by 10%!
To lower the impact of rising rates, look at ways to pay off variable rate loans faster through accelerated or lump-sum payments.
Convert and consolidate debt
You might want to consider amalgamating and converting your variable debt to a fixed rate loan. Keep in mind that fixed rate loans usually have higher interest rates than comparable variable rates - you are paying for the certainty. Run the numbers and see how much you would be able to afford if rates increased by 2% or 3%.
Fixed rate mortgages reset every five years in Canada; even if you're in a fixed rate mortgage today, at some point you will have to renew at a higher rate. That's why switching to a fixed rate mortgage might be good in the short-term, but you still want to reduce your outstanding debt as much as possible.
If you have high interest debt, try consolidating it into a lower rate offering to make repayment more manageable. When you refinance your mortgage, discuss consolidation options with your lending institution and shop around for the best rates.
Become a lender
Raising interest rates can be good news for savers. If you have money saved up, think of it as having money that you can 'lend' to others. In reality, you are typically lending to the government (buying government bonds and GICS), or companies (buying corporate bonds). This means that when interest rates rise, you can get a higher return when you let others borrow your money.
There is a caveat to this approach; bonds that currently pay low interest rates will decrease in value, since new bonds that are issued will provide investors with higher rates. Blindly investing in fixed income instruments isn't a good strategy, so make sure you do your own research or work with a professional who can provide advice in this area.
When it comes to managing debt, you can do a 'stress-test' on your finances to see how rising interest rates would impact you. Although economic news can be pretty boring, try paying attention to headlines that reference raising rates, as it could have a direct impact on your financial situation. Ultimately, you want a concrete financial plan that lays out your objectives and provides a clear strategy for achieving them.