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With the recent interest rate cut, MNP cautions Canadians against diving into unneeded debt.
The Bank of Canada announced on Jan. 21 the interest rate had been cut by 0.25%. Although good news, MNP personal bankruptcy trustees caution Canadians about taking advantage of this decrease by taking on more debt.
“Although much better than a rate increase, the Bank of Canada appears to be utilizing the rate cut as one tool to mitigate the effects of declining oil prices,” says Randy Kobbert, CIRP, MNP trustee.
Randy explains that a change in the Bank of Canada rate (the rate at which Canadian banks may borrow from the Central Bank) leads to corresponding changes in the prime-lending rate at the chartered banks — the rate, which determines how much we pay the bank for lines of credits and other floating rate consumer and business loans.
So far, the banks have not followed suit and as a result, small business and consumers may not benefit much from this. From a perception standpoint, any kind of interest rate cut helps the public feel like they have more spending power, even though the actual benefit may be insignificant. In Canada, the household debt-to-income ratio is currently at a record high of 162.6%.
Donna Carson, a personal bankruptcy trustee with MNDPDebt.ca, offers several suggestions. First she says to focus on paying down the principal now. Second, to start a rainy day fund. Finally she recommends locking in at a low interest rate.
“Do not allow yourself to feel as if you have more to spend, based on the recent announcement. As usual, one of your primary financial goals should be to budget for debt repayment, starting first with high-interest credit cards,” she adds.
If you are able to, consolidating consumer debt into one payment is always a good idea. If your financial means are limited and you can’t afford the inevitable rate increases that remain on the horizon, now may be a good time to lock into a fixed rate for that loan, mortgage, renewal or new mortgage.
“If you stay with a variable rate loan, consider keeping your payments the same and prepaying your principal — assuming you have no high-interest credit card debt. Ideally, your only debt should be what you borrowed to help you earn income and therefore generally tax deductible. Otherwise, consumer debt is a product of spending more than you earn, so it’s about distinguishing needs from wants, establishing a budget and sticking to it,” explains Randy.
The announcement of a lower interest rate may sound great to consumers. However, consumers won’t be significantly affected by it, as long as they’re not encouraged to spend more on credit.
At this point in time, the rate cut is mostly beneficial to big business to defray their operating costs. These savings are not noticeably passed along to individuals in most cases. There have been a few announcements by banks regarding short-term mortgage rate drops. However, long-term mortgage rates aren’t generally affected by adjustments in the Bank of Canada rate. On a larger scale, rate changes can affect global factors such as foreign exchange rates, costs to import and export goods and inflation, but these are generally negligible on an individual scale.
Be prepared for the unexpected. At MNP, we suggest creating a rainy day fund, by putting aside money regularly for areas such as future interest rate increases, job layoffs or unexpected bills. It’s also important people ensure their savings are realistic.
“An interest rate drop is one form of stimulus the Central Bank can use to encourage increased spending by businesses and individuals — some of the prime drivers of growth in the economy,” explains Randy. “This is particularly beneficial when there are counter-balancing events occurring that can discourage spending, such as declining oil prices, leading to concerns about business profitability and future employment.”
The only way a decrease will noticeably benefit consumers is if the chartered banks agree to adjust their prime rates a corresponding amount. We want consumers to take a close look at their debt and look at ways to pay it down now, not borrow more as this is the time to pay back debt.
In summary, this announcement doesn’t mean it’s time to start borrowing more. Interest rates will indeed go up eventually and when they do, Canadians will want to put themselves in the best financial position possible. Household debt-to-income ratios in Canada at a record high of 162.6% is evidence that spending has been outpacing debt repayment for years in this country. Now is the ideal time to take stock of your financial situation and choose ways to decrease their overall debt. If you are finding it overwhelming, debt professionals are available to assist.
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