How Will Higher Interest Rates Affect Me?

Canadians have enjoyed low interest rates for the last decade, but even more so since the onset of the global pandemic, when the Bank of Canada responded with a trio of rate cuts, bringing us to 0.25 per cent. But while the central bank has left interest rates alone at the latest policy meeting, officials have raised the benchmark policy rate by about 500 basis points to their highest levels in more than two decades. Economists say the verdict is still out on whether the BoC will pull the trigger on another rate hike amid a re-acceleration of inflation; the consensus is that rates will be higher for long. Now, you might be wondering: How will higher interest rates affect me? What does an interest rate hike mean if you’re planning to buy a home, if you already have a mortgage, or are carrying any other debt? Let’s take a step back to better understand what causes movement in interest rates and how a higher rate might impact you. What Causes Interest Rates to Rise or Fall? The Bank of Canada is our central bank. The chief of the Canadian Central Bank is Tiff Macklem. Macklem and the Governing Council are responsible for establishing monetary policies, dictating interest rates, acquiring government securities, and printing money. Per the Bank, its principal role is “to promote the economic and financial welfare of Canada,” as defined in the Bank of Canada Act. “At the heart of the Bank’s monetary policy is a commitment to maintain low and relatively stable inflation—in particular, to keep the rate of inflation close to the two-per-cent midpoint of the one- to three-per-cent target range,” according to the Bank’s website. A good example of this tool at work is March 2020, when the Bank implemented historical interest rate cuts in an effort to protect the Canadian economy from the fallout of COVID-19. How do interest rates affect the economy? The Bank’s key interest rate remained unchanged for about two years, sitting at 0.25 percent. A low rate aims to boost the economy when a slowdown is anticipated, and it serves as a guideline for other big banks and lenders when they set their own interest rates, including mortgage rates. The hope is that reducing the cost of borrowing will encourage consumers to keep spending, and thus, the economy keeps humming along. We’re now on the other side of the pendulum swing, with an increasing interest rate to tamp down soaring inflation. How Will Higher Interest Rates Affect Me? What happens when interest rates rise? As the economy recovers, interest rates will typically rise (or, as we saw in the wake of COVID-19 in a down economy, they will fall). When the Bank makes changes to the policy interest rate, similar adjustments can occur in short-term interest rates, including the Bank’s prime rate, which can be a reference point for big banks and other lenders when they determine their own interest rates. A higher interest rate means borrowing money is more expensive. This applies to a whole host of goods and services: car and student loans, lines of credit, outstanding credit card balances, and mortgages. On the flip side, if you have investments or money parked in a high-interest savings account, you may see higher returns. If you already own a home and are locked into a fixed mortgage rate, a higher interest rate won’t affect your mortgage payments for the term of your mortgage. When it’s time to renew, you may be doing so at a higher rate, which means less of your hard-earned money is going toward paying down your principal loan. An interest-rate hike will mean a larger portion of your regular mortgage payment will be allocated to interest versus principal if you have a variable-rate mortgage. Meanwhile, those who are in the market to buy a home will feel a more immediate pinch in the form of a higher mortgage interest rate. And if you’re hoping to buy a home in a pricey market, such as the Toronto or Vancouver real estate markets, that pinch could feel more like a punch. Depending on the amount borrowed, even an increase of one percent can mean thousands more paid in interest over the life of a mortgage. Those who are also carrying other forms of debt, such as credit card balances, will also get hit with a higher cost of borrowing. How Could This Change Impact Canadian Real Estate? When the Bank of Canada started its quantitative tightening cycle, homeowners and homebuyers saw the pandemic-era red-hot Canadian housing market experienced a modest correction. It was not as much of a downturn as some had worried about; it was notable enough to allow prospective homeowners to sneak in and try to take advantage of less expensive conditions. One reason for the high demand and flurry of market activity that took place in 2020 and 2021 was the rock-bottom interest rate. This prompted many prospective homebuyers to get off the fence, so to speak, and expedite their purchase to take advantage of the attractive rate and enjoy a better bang for their buck: greater purchasing power for a larger space. (That is, if they could find a home to buy in the tight housing sector.) On the other hand, could a higher interest rate heat up the market? The Canadian real estate market is seeing this happen in several pockets of the country, especially in strong major urban centres, mainly because of the scarcity of inventories available. In other environments, this type of scenario might have been unlikely once higher interest rates went into effect. Today, however, home-buying activity has been robust, and many forecasts anticipate a resilient real estate market. How to Prepare for Higher Rates Ahead The verdict is out if the Bank of Canada has one more rate hike left in its tightening arsenal. That said, now that you have a better idea of how higher interest rates may affect you, what can you do to prepare for the inevitable pinch to your pocketbook? Pay down your loans as much as possible while interest rates are still low. Remember, whether it’s a mortgage or another type of loan, a lower interest rate means more of your payment goes toward paying down the principal. If you’re carrying multiple debts, consider paying down the higher-interest ones first since those debts are more expensive to carry. If you’ll be shopping for a home, get pre-approved for a mortgage. Not only does this give you a good idea of how much you can spend, but doing this also locks in the current (lower) rate for a period, often 90 or 120 days—and getting pre-approved costs you nothing. If you have a variable-rate mortgage, discuss your options with your lender or financial adviser and consider locking it in for a fixed term at the current lower rate. Of course, it’s always wise to discuss the details of your financial situation and goals with an accredited financial adviser. Speaking of professional help, work with an experienced real estate agent to navigate the Canadian real estate market and find your dream home.

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