On July 12, the Bank of Canada raised its key interest rate by 25 basis points, from 0.50 percent to 0.75 percent. The upward move, the first in seven years, was quickly followed by Canada’s largest banks raising their prime interest rates.
While an uptick in the overnight lending rate is a sign of the government’s confidence in the growth of the Canadian economy, it has specific financial implications for Canadian consumers. Homeowners and prospective homebuyers, in particular, will now have to contend with a greater cost of borrowing and homeownership, which could potentially alter their financial planning.
Canadians should be concerned, because many of them do carry large amounts of debt, says Nathan Giesbrecht, Regional Director at Investors Group. “If we go with the average mortgage in Canada being around $350,000, the recent increase in the interest rate would mean an extra $875 a year in interest,” says Giesbrecht. “So, $75 a month extra is now going to the lender, regardless of their current mortgage rate.”
With the prospect of further rate increases – economists expect another 0.25 percentagepoint hike in October – prospective homeowners shouldn’t do their mortgage calculations on 2.5-percent five-year fixed rates anymore, but on a more realistic 5-percent to 6-percent five-year fixed, he says.
Financial plans may also need to change, says Daniel Collison, a Toronto-based Regional Director with Investors Group. Consumers should anticipate and prepare for higher rate increases down the road. “As interest rates go up and investors renew their mortgage terms, they’ll need to consider the impact on their weekly and monthly cash flow,” he says. For instance, someone with a $400,000 mortgage at a 2.5-percent interest rate may be paying about $448 a week, but a 1-percent hike will increase their weekly payout by about $50. If interest rates go up by 2 to 4 percent, they could be faced with an additional $100 per week on their mortgage payment, he explains.
The BoC’s decision to hike rates also serves as a reminder that consumers need to periodically stress-test their mortgage at a higher rate. “I doubt very many have been doing it, and that’s where the shock will come in,” says Collison. “A small increase like the one last week isn’t going to be detrimental to a lot of people initially, but over time if those rates do increase, you’re going to feel it.”
Therefore, now may be a good time to switch to a fixed-rate mortgage, before the rate rises again. “I’d say homeowners really want to be ready to lock in,” says Collison. “If a five-year lock-in term at a rate that you can afford gives you comfort, then you should consider that.”
There are also implications for investment portfolios, particularly fixed-income securities, says Giesbrecht. Typically, when rates rise, bond prices drop in value. Those who have a high concentration in bonds could see their investments take a hit. Investors, he adds, should have diversified portfolios and consider investment vehicles that hedge against the negative impact of rising interest rates.
However, there are benefits to rising rates, including potentially earning more interest in a savings account. Mounting rates tend to strengthen the Canadian dollar, too. “Rising rates can help if you’re looking to buy some U.S. dollars for investing in U.S. real estate, or buying American securities,” says Giesbrecht. “If you wanted to buy a U.S. company, for example, it might be a little cheaper if your dollar was a tiny bit stronger today than it was a week ago.”