A lot has changed since last Wednesday. As predicted by economists and financial experts throughout the country, the Bank of Canada finally raised its overnight interest rate on July 12, 2017, by a quarter of a percent, from 0.50% to 0.75%.
This is big news (so big in fact, that I’m actually writing about it!) because the BoC has kept interest rates historically low since 2010, as you can see from the chart below. To give you some perspective on past BoC interest rates, the interest rate was at an all-time high in Feb. 1991 at 16%, and was at an all-time low in April 2009 at 0.25%, as documented by Trading Economics.
This choice to keep interest rates low was impacted by the recession in 2008 and the oil crash in 2014, and was a way to stimulate the economy. But, since the economy is now on an upswing, the Bank of Canada finally felt it was time to raise its overnight rate after 7 long years.
Why this is of any significance to you is because when the Bank of Canada raises its interest rate, the banks do too.
You see, the Bank of Canada has its key interest rate and the banks have what’s called the prime rate, which is the “annual interest rate Canada’s major banks and financial institutions use to set interest rates for variable loans and lines of credit,” (RateHub). The prime rate was at 2.70%, but after the BoC raised its interest rate, the prime rate increased to 2.95%.
Here’s another fun chart to show you what the prime rate has been set at throughout the past 10 years.
That means if you’re borrowing money and it’s at a variable rate (not fixed), then that loan just got more expensive.
What the Bank of Canada Is All About
As a quick refresher, the Bank of Canada is Canada’s central bank. As stated in the Bank of Canada Act, its main functions are to “…regulate credit and currency in the best interests of the economic life of the nation, to control and protect the external value of the national monetary unit and to mitigate by its influence fluctuations in the general level of production, trade, prices and employment, so far as may be possible within the scope of monetary action, and generally to promote the economic and financial welfare of Canada.”
To break that down a bit more, the Bank of Canada uses its monetary policy to stabilize inflation (so it stays low). It’s responsible for designing, issuing and distributing Canada’s bank notes (like the new $10 bill that will feature Viola Desmond). It manages the federal government’s public debt programs and foreign exchange reserves. And lastly, it promotes safe and efficient financial systems nationally and internationally.
What This Interest Rate Hike Could Mean for Your Mortgage
Okay, now that that’s out-of-the-way, let’s talk about what this recent interest rate hike means and how it could impact your current financial situation.
When the news broke out, I immediately shared it in my private Facebook group to see what everyone was thinking. It was great to hear everyone’s thoughts and perspectives, though many of the commenters weren’t too concerned about the rate hike since they were either debt-free or carrying fixed rate mortgages.
That’s pretty much my situation. The only debt I’ve got is my fixed rate mortgage, which is on a 5-year term (4 more years to go). Once the announcement came down, I was so thankful that I listened to my gut and got a fixed rate mortgage. My husband and I knew we could have gotten a lower rate with a variable rate mortgage, but we were fine paying a little extra for peace of mind. Though, the interest rate hike will be something we’ll have to deal with when our term is up.
That being said, if you’re reading this and saying “Uh oh, I’ve got a variable rate mortgage!” don’t freak out. First off, you’re not alone. According to RateHub, 29% of total mortgages in Canada are variable rate. Secondly, you do have the option to lock in your variable rate mortgage to a fixed rate mortgage.
To get some more information on how this works, I spoke with RateSpy.com Founder Robert McLister.
First off all, if you are feeling a bit concerned about rising interest rates and wish you’d gotten a fixed rate mortgage in the first place, it’s not too late. You do have the option of switching your current variable rate to a fixed rate mortgage with your current lender, and most lenders don’t charge you any extra fees for this.
However, it will still cost you. As Robert told me over the phone “Never get a variable rate mortgage if you plan on locking it in later,” and he’s got a good point. Although you may think that locking it in will save you money down the road, there are a number of variables to consider first.
For instance, just because you’re switching to a fixed rate, doesn’t mean you’ll get the same best fixed rate a new borrower would get. Conversion rates are usually much higher than regularly advertised fixed rates, because your lender incurs additional costs for switching you from a variable rate to a fixed rate mortgage.
Most lenders also require you to agree to a term the same length as your current term, if not longer. So, if you have another 3 years left on your term, your lender would either require you to lock in for another 3-year term if not a 5-year term.
At the end of the day, depending on what you’re currently paying for your variable rate mortgage, it might just make financial sense to keep it variable. Most economists don’t see interest rates sky rocketing anytime soon, though they are on the incline. It’s really a matter of you crunching your numbers to see if it’s worth making the switch to a fixed rate mortgage or sticking with your variable rate mortgage until your term is up.
Another tip if you don’t currently have a mortgage but are thinking of getting one, this is definitely a good time to get a 5-year fixed mortgage. Fixed rate mortgages will also go up, so there’s no time like the present to lock down a good rate in right now.
What This Interest Rate Hike Could Mean for Your Line of Credit
Home Equity Lines of Credit (HELOCs) and most unsecured lines of credit have variable rates, which means that if you have one, you’ll be paying more for that debt now than before the announcement happened.
This is a big reason why I try to stay away from debt whenever possible. That still doesn’t stop any bank I’ve ever been a client of from sending me letters in the mail pre-approving me for lines of credit I never asked for. You see, it’s just too easy to get credit, but it can be hell trying to climb your way back into the black.
Still, if it’s too late to prevent this and you’ve already got a line of credit you need to pay back, this is the time to start making a concerted effort to pay it back down to zero, then closing it up for good. Interest rates have gone up, but they aren’t going to stop where they are. They will continue to rise, which means it will be cheaper to pay back what you owe now than a few years down the road.
What This Interest Rate Hike Could Mean for Your Student Loans
Even though you’ve got a 6-month grace period after graduating before you’re required to start paying off your student loans, there are a few important things to remember.
Firstly, if you’ve got Canada Student Loans, you’ll still be charged interest on those first 6 months (so if you can, start paying them back right away).
Secondly, student loans are also affected by the Bank of Canada’s interest rate hike. Take Canada Student Loans as an example. You get the choice of paying these back at either a fixed interest rate or a floating interest rate. The fixed rate is currently set at prime + 5%, and the floating rate is set at prime + 2.5%. The BoC’s rate hike won’t affect fixed rate student loans, but it does mean you’ll be paying more for that loan if you’ve got a floating rate. All the more reason to start paying that student loan back as aggressively and as soon as possible.
Here’s What You Can Do About It
So, most of what I wrote sounds like bad news. I totally get it. The only people that aren’t tearing their hair out are the one’s without any debt at all. But if there’s any silver lining at all, here it is.
If you’ve got a bunch of debt and you’re freaking out right now, this is your wake up call. Debt’s been cheap for way too long, and too many people were starting to believe it would stay that way for years to come. Well, that’s not the case anymore. Interest rates are up, debt isn’t as cheap anymore, and if there was ever a time to start taking your debt seriously and make a plan to become completely debt-free…THIS IS IT!
To get you started, here are a few helpful tips you can start doing right now to improve your situation:
- Don’t take out any more loans. If you were thinking of getting a HELOC to renovate your kitchen, it’s time to revise that plan. How about instead, making a list of everything you want to upgrade or fix in your kitchen, calculating how much it’ll cost you, then making a plan to save up every dollar so you can pay for it in cash. Because at the end of the day, you don’t really NEED that kitchen renovation. It’s a WANT. So if you want it, save up for it and be patient about it.
- Cut your expenses. If you’re worried that you won’t be able to afford everything with this new interest rate hike, then it’s time to look at all of your fixed and variable expenses, and cut back on everything that’s not absolutely necessary. Believe me, once you cut back, you’ll hardly miss those things you used to waste your money on (this is coming from someone who hasn’t had cable for 5 years and is totally fine!).
- If you still want to get a mortgage to buy a home, that’s still fine. But remember, just because you’re pre-approved for a certain mortgage amount, that doesn’t mean you can actually afford all of that mortgage. Especially now that interest rates are up. Only take the amount you actually need, and get a fixed rate mortgage since rates are going to continue to rise over the next few years.
- Make sure you’ve got an emergency fund, and if you don’t, start saving money for one. It is literally the simplest thing you can do to prevent yourself from taking on more debt to afford your lifestyle. All it takes is saving up 3-6 months’ worth of your living expenses (or more), putting it into a high-interest savings account, and not touching it until there’s a real emergency.
What are your thoughts on the interest rate hike? How has it affected you?