Pattie Lovett-Reid: Bank of Canada rate hike may fuel debt spirals
As widely expected, the Bank of Canada increased its key interest rate target by a quarter of a percentage point to 1.25 per cent.
Sure there will continue to be unknowns such as the full impact of rate increases, an uptick in minimum wages, the potential fallout of the mortgage stress test implemented on Jan.1 – and of course, NAFTA. While there are wildcards, the real issue will be whether the Canadian economy can withstand additional rate increases this year. That remains to be seen, but that doesn’t mean there won’t be an impact in certain sectors, specific industries, investments, and currencies.
So let’s break it down:
- We are still in a borrower’s environment. Sure, fixed term mortgages have ticked higher and now variable rates will move yet again but the reality is we are still in an extremely low interest rate environment. Savings rates will move as well, money markets and GICs. However, if history is any indicator, they won’t move all that much and tend to lag inflation, which we know is still stubbornly low. If you are investing in a GIC, I would consider laddering my investments over a five-year period betting on the fact a year from now your return could be incrementally higher.
- If you are an existing homeowner and your mortgage is up for a renewal, it is going to cost you more. So get ready for it. That doesn’t mean you are headed toward financial ruin. The banks have proven to be very prudent lenders and while some may be betting against them, so far, they have shown strong stewardship through the economic downturn and now the recovery. As CIBC Capital Markets Chief Economist Avery Shenfeld recently said in an interview on BNN when asked why a Canadian housing slowdown won’t mimic the U.S. housing crash, he said: “We don’t really look anything like the U.S. … We haven’t given out mortgages to people whose only qualification was a pulse.” In the meantime, if you are wondering how much more you will have to pay at renewal, all the financial institutions have financial calculators to assist in crunching the numbers.
- It could take you longer to pay off your mortgage. Home equity lines of credit with monthly interest payments would go higher. That could impact the speed at which you become mortgage-free as many who borrow against their home typically pay off the line of credit when they sell their home. The knock-on effect here is higher interest servicing costs leaves less disposable income to reduce the balance owing on outstanding debt. Wondering what to do with a little extra cash? Pay off the line of credit, then your mortgage.
- Banks love a rising interest rate environment, as do insurance companies and even pension funds. Companies with long-term funding commitments are helped when rates go higher. Having said that, it’s not great news for the government, which means it’s not great news for us . The government is a big borrower and their debt too gets a lot more costly resulting in less tax revenue toward healthcare, infrastructure, etc., and more toward interest payments.
- Investments have performed much better than savings. With little incentive to tuck money into savings accounts, Canadians have been plowing money into the markets. It is never a bad time to check in on your asset allocation to ensure in a search for yield you haven’t taken on more risk than you are comfortable with.
Are you still questioning why you would want to pay down debt in this low interest rate environment? As rates go higher, borrowing gets more expensive and housing may cool off – not collapse, but cool. Debt is not a bad thing but you do have to pay it back. And from my perspective, the sooner the better.
If you are even a little stressed about higher rates, we’ll end on a positive note: The Canadian dollar continues to hold above 80 cents US, so it might be a good time to buy your U.S. currency if you a planning a spring getaway.