Those with variable rate mortgages or lines of credit have likely noticed that their debt payments have climbed over the last year. That’s because the Bank of Canada has increased the overnight rate – a short-term interest rate that factors into lending costs – four times over the past 12 months. With the Canadian economy continuing to do relatively well, rates could increase further over the coming year.
Most people know that rising rates impact mortgage costs, but the increase in rates impacts other parts of our lives, too.
By now, most people know that rising rates impact mortgage costs – variable rates rise when the overnight rate climbs and it also becomes more expensive to renew a fixed rate mortgage – but the increase in rates impacts other parts of our lives, too, says Steve Rogers, a Toronto-based investment strategist with IG Investments.
Borrowing becomes more expensive
One of the biggest changes is to the cost of variable-rate non-mortgage credit, like home equity loans or lines of credit, says Rogers, which “make up a big chunk of a lot of people’s balance sheets.” When debt increases, consumer behaviour can change – higher interest payments can result in less discretionary income – and that could have an impact on the Canadian economy. “People might think twice about how often they go out for dinner and their spending around the holidays,” says Rogers.
Businesses must pay more, too
Borrowing costs don’t just rise for individuals, they climb for companies, too. One of the reasons why the Bank of Canada lowered rates in the first place – in 2015 when the Canadian economy was hurting due to a plunge in oil prices – was to encourage businesses to invest in their operations. Now, with rates rising, business owners will have to pay more to borrow money. As well, if consumers do spend less, then businesses, particularly ones that sell more discretionary items, could see demand for their goods decline, says Rogers.
Big impact on bonds
Investors also need to pay attention to rising rates. When rates climb, bond prices fall. Why? Because people would rather buy a bond with a higher yield – fixed income yields tend to rise when interest rates increase – and that makes existing bonds less attractive to investors and, therefore, cheaper to buy. Since most Canadians own some bonds, they could see losses in that part of their portfolio, says Rogers. However, when that bond matures, the investor, or more likely the fund manager running the bond portfolio the person is invested in, can buy new bonds at now higher yields. “Anybody with a bond portfolio could see some capital losses,” says Rogers. “On the flipside, the income they earn will hopefully go up in the future.”
Some sectors could struggle
Certain sectors, such as real estate investment trusts, utilities and other industries with companies that pay high dividends, might also take a hit. When bond yields fell, these sectors became popular with investors who were looking for investments with strong payouts. Now that fixed income yields are rising, these equities start to become less attractive for dividend-seeking individuals, as they’d prefer to buy a well-paying, but less risky bond to a more volatile stock. “The higher the rates go, the lower the demand could be for these sectors,” says Rogers, adding that this is one potential impact of rising rates and not something that’s certain to occur.
There is one big benefit to rising rates: investors may be able to earn more money. Bank account yields, which have been low since rates started falling, will eventually rise as the overnight rate increases, which means people can earn more money on the savings they keep at the bank. As well, rising rates are a sign of economic growth and if the economy does continue to expand then that’s good for business – and, potentially, stock prices. “Anyone drawing income from their investments ought to see more,” says Rogers.
So, what can people do? It’s a good idea to pay down any variable rate debt – put money towards your line of credit, for instance – and talk to an advisor about how rates might impact your portfolio. While borrowing may get more expensive, the fact that our economy is improving is ultimately a good sign for Canadians – and their wallets.