Managing your finances when interest rates rise

Canada’s inflation rate rose to 8.1 percent in June 2022, which is the highest we’ve seen it in nearly 40 years. When the rate finally dropped to 7.6 percent in July, it was the first monthly decline in nearly a year.

The Bank of Canada has raised the key overnight interest rate seven times this year in an effort to manage the inflation crisis — most recently today when it increased the benchmark interest rate to 4.25 percent. This is the highest the interest rate has been since before the 2008 financial crisis. However, unlike with previous rate hikes where the Bank of Canada indicated the interest rate would need to rise further, this time the central bank expressed more caution about future increases.

How you can be affected

The steady rise in interest rates will affect you if you have a mortgage, line of credit, or other loans subject to variable interest rates (that is, an interest rate that increases or decreases over the term of your loan). Some likely impacts to your day-to-day costs include:

• Increased mortgage pressures: Homeowners can expect to pay more on their mortgage with even a slight increase on interest rates. Those with variable rate mortgage will feel the impact in shorter time while fixed rate mortgage owners will likely see a fairly steep increase to monthly payments when it’s time to renew. Prospective homebuyers may find they qualify for much less than anticipated, or may no longer qualify for a mortgage at all.
• Higher borrowing costs: Interest payments on variable rate car loans, student loans, and lines of credit will continue to rise along with the overnight rate. These added costs may also make it difficult to keep up with fixed interest rate debts such as credit cards, as borrowers will have less income available in their budget overall.
• Uncertainty and reduced confidence: Higher costs due to inflation are already causing consumers to think twice about how they spend. Now, a persistent rise in interest rates is making people even less willing to take risks.

There is some good news, though. Because the same overnight rate that influences borrowing costs also guides what banks will pay in interest for savings accounts and guaranteed investment certificates (GICs). For those who are able, this is a good time to begin building up an emergency fund and setting money aside for big purchases (e.g., vacation, home ownership, etc.).

Managing your financial health

As government attempts to cool the heating economy, you may need to take precautionary measures to save your financial health. Here are some strategies to help you get along today and prepare for the future:

• Change your spending habits. Revisit your monthly budget and reduce discretionary spending on dining out, entertainment and travel. Apply the savings to non-discretionary expenses like housing, groceries, and paying down debt.
• Use the debt avalanche method of paying off debt with high interest rate first. Continue paying the minimum on all your other debts. And as you pay each debt off, use the extra funds to repay the next highest interest loan and so on. Just make sure you have budgeted enough funds for living expenses and emergencies.
• Consider if debt snowballing is a more suitable strategy for your situation. This method involves paying off your smallest debts first instead of those with higher interest rates. It will cost you more in the long run, but many people find the instant gratification is a worthwhile trade-off to keep them motivated.
• Look into consolidation loans. If most of your debt is concentrated in high interest vehicles such as credit cards, you may benefit from paying these off with a single loan with a lower fixed interest rate.
• Avoid incurring further credit. Use Interac or operate on a cash basis where possible.

Speak to an advisor

Seek professional help immediately if you’re having trouble managing your debt. MNP Licensed Insolvency Trustees offer a free and non-judgemental assessment of your financial situation. Together, we’ll review your financial situation and consider all your options for overcoming your debt — including Bankruptcy, Consumer Proposal, debt consolidation, and more. You under no obligation to participate in any of the services MNP offers, and we’ll provide an unbiased expert opinion of which solution would work best for you.