Could higher interest rates impact my finances?

With rate changes likely on the way in 2022 and inflation taking hold, it’s a good chance to revisit your budget, buying decisions and certain parts of your finances.

If interest rates go up, watch for impacts to your budget

Canadians have been living in a low interest rate environment since the start of the pandemic, but with inflation rising to record levels, there are signs this could soon be changing. You may be wondering how this might affect your mortgage and other family finances — and whether you can do anything to ease the impact on your bottom line. 

For now, in early 2022, the Bank of Canada is holding its key lending rate at 0.25% — where it has been sitting since March 2020. But it recently signaled that rates will likely need to increase soon, as inflation is sitting near 5% — the highest level in 30 years, according to Statistics Canada. This is far above the Bank of Canada’s target of 2%. 

With rate changes on the way in 2022, inflation taking hold and Canadians carrying some $2.5 trillion in outstanding debt last year (two-thirds of which was mortgage-related and the rest in other types of debt such as credit cards, car loans and lines of credit), it’s a good chance to revisit your budget, buying decisions and certain parts of your finances. Here are a few areas to think about: 

Grocery shopping, gas and more 

Inflation is set to impact many of the goods in our day-to-day lives, so your salary will have to stretch further to cover your purchases this year. As Canada’s Food Price Report 2022 forecasts, overall food prices will increase by 5% to 7% this year. This is due to high inflation and pandemic-fueled supply chain disruptions driving grocery store and restaurant prices higher. 

Indeed, says Statistics Canada, vehicles and household appliances also saw significant price increases at the end of the year, and gas prices rose more than 40% between the end of 2020 and 2021.

Consumers’ purchasing power just can’t keep up — with wages rising only 2.6%.

Managing your cash flow and budget 

Taking steps to manage your personal budget is one way to help combat inflation when it comes to purchasing goods and protecting cash flow. As the Credit Counselling Society explains, grocery dollars can go further when you stock up on sales, shop in bulk, cut back on pre-packaged foods and avoid impulse buying.

Also, consider holding off on making larger consumer purchases, such as a new appliance or a large piece of furniture, until inflationary pressures ease. Also consider putting money aside for those wish list items in a High Interest Savings Account until it’s a more favourable time to buy.

Review your loans and debts

If you hold loans with a variable rate – maybe a car loan, a home equity line of credit or certain types of credit cards — the interest rate you pay is tied to the bank’s prime lending rate, which is influenced by the Bank of Canada’s overnight rate. When rates go up, so will your repayment requirements. Consider calculating how your payment may be affected by several interest rate increases and factor this amount into your monthly budget now to avoid surprises.

Decisions around your mortgage

For homebuyers and homeowners, the prospect of a rate increase might seem like a good time to consider your options, particularly if you’re weighing the benefits of a variable-rate versus a fixed-rate mortgage — or wondering whether it’s time to lock your current mortgage rate in. 

Variable-rate mortgages, often for five-year terms, are also tied to the bank’s prime lending rate. Therefore, variable rates can fluctuate over the term of the mortgage.

fixed-rate mortgage, on the other hand, sets the interest rate for the term of the mortgage. This gives you a bit more stability in what you’ll pay each month, however, it could be more or less favourable than the variable rate. 

Should I choose a variable-rate or fixed-rate mortgage?

While it may seem like better financial sense to opt for a fixed-rate mortgage when interest rates start to rise, there are certain things to consider: 

  • Fixed-rate mortgages have also increased in recent months, led by rising government bond yields. The average five-year fixed rate on a new insured mortgage has climbed 20 basis points in 2021, according to Canadian Mortgage Trends.
  • With a variable-rate option, you can choose to lock into a fixed rate according to your lender policy. Wyth mortgage customers can convert from a variable to fixed rate at any time, effective on the next payment date — without fees or a prepayment penalty.
  • But the decision to lock in or not will likely come down to a calculation of how a rate increase (or several rate increases) will affect your payment amounts. You’ll also want to compare the variable rate to the fixed rate you’re being offered.
    • For example, if you’re paying a variable rate of 1.55% now, locking into a fixed rate of more than 2.74% might only make sense if the Bank of Canada raises rates several times during your term.

Ultimately, you’ll likely have to weigh your desire for certainty, or locking into a particular fixed rate now, against wanting to enjoy a lower payment for as long as you can.

As always, it’s important to speak with your mortgage specialist regarding your mortgage rates, agreement, terms and conditions, as everyone’s situation is different.

Note: All rates are for demonstration purposes. See Wyth’s current mortgage rates.

Aren’t I already stressed enough?

For homebuyers, higher interest rates may also impact the mortgage stress test.

To qualify for a mortgage, you need to prove you can afford payments, based on a qualifying interest rate. This is the higher of either 5.25% or the interest rate you’ve negotiated plus 2%. Qualifying for a higher interest rate means you’ll also likely need to prove you can afford to carry larger payments.

Revisit your investment strategy 

With the potential for interest rates to rise, fixed-term investments such as Guaranteed Investment Certificates (GICs) might also start to look interesting as their interest rates also become more attractive. 

As their name suggests, GICs offer you a guaranteed interest rate for a specified, locked-in time period, often offering higher rates for longer terms. But it’s important to consider that locking-in means that while you’ll be guaranteed that rate when the GIC matures, you won’t be able to take advantage of any interest rate increases in the meantime with that locked-in money.

Know your options 

While rising inflation and the possibility of interest rate increases may have you feeling stressed about the impact on your wallet this year, take the time to understand how this may affect your personal and family budget. By making changes, including adjustments to your saving, spending and investing, that work best for your situation, you can move forward with confidence through this period of uncertainty.

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