How you can save a few bucks as inflation, interest rates rise
After two years of record low interest rates, Canadians are being hit with rapid increase.
The Bank of Canada’s overnight interest rate was set at 0.25% in March of 2020 and stayed there until March of this year. On June 1, a 0.5% increase, the third hike this year, brought it to 1.5%.
In the U.S. today, June 15, the Federal Reserve pushed its benchmark rate up by 0.75% to between 1.5% and 1.75%, the largest jump since 1994.
Should you be worried?
That depends on whether you’re one of the 50% of British Columbians cited in a Professional Chartered Accountants of B.C. report who say they are $200 a month in payments away from insolvency or if you’re in the other half who can afford new homes and foreign vacations.
“What I find with those surveys, is people are always saying: ‘I’m really close to filing bankruptcy,’” Andrew Smith, an insolvency trustee in Surrey and member of the accountants association, told iNFOnews.ca. “What we see as trustees is someone who is struggling today might still take two or three years to deal with the actual root of their problem because there’s a stigma to it. They feel like things will maybe change, they’ll get a better job and pay more. Maybe doing something today might actually improve your financial situation in two to three years.”
For people living paycheque to paycheque, Canada’s rising food and gas prices puts their ability to handle their debts in jeopardy.
For every $1 Canadians earn, they carry $1.83 in debt, Smith said.
A good chunk of that debt is mortgage payments. That’s a good thing in terms of home equity as housing prices rise but not so good when it comes time to renew mortgages.
READ MORE: How Thompson-Okanagan housing markets may react to rising interest rates
Those with fixed mortgage rates with a few years left until renewal time have nothing to worry about. For now.
Those with variable interest rates won’t see their monthly payments change but, when it comes to renewal time, they’ll have paid more in interest and less of the principal.
It’s time for many to do some math – either using online mortgage calculators or consulting mortgage brokers, accountants or bankers.
To break a mortgage early can cost thousands, even tens of thousands, of dollars. That breakage rate is usually based on three months of interest payments or the difference between the old and new interest rates, whichever is higher.
But, for every half-per cent increase in mortgage rates, that adds more than $30 per month in payments for each $100,000 borrowed.
“It’s an exercise we should all do because, if you can save yourself even $10,000 or $20,000 over the life of the next mortgage term, that’s just going to be more money in your own pocket,” Smith said.
Homeowners with the most to worry about are people who have seen the equity in their homes increase through the real estate boom and taken out home equity loans.
Those loans are generally based on flexible interest rates so, as the Bank of Canada rates goes up, so do the monthly payments. That can stretch already tight budgets.
For those living paycheque to paycheque and paying rent, it’s inflation not interest rates that will have the biggest impact.
But, as they struggle, they shouldn’t bury their heads in the sand, ignore their debts and hope things improve.
“It’s always better to talk to a creditor than miss a payment,” Smith said, adding that resorting to payday loan outlets is not a good tactic.
“Sometimes it’s really hard to get help from a bank once you’ve got into a payday loan,” Smith said. “You might already be in a position where you have lower credit or your credit rating might already be taking a hit so the bank might be less willing to help you out in that situation.”
People like himself, a licenced insolvency trustee, are there to help at no cost. They can help set up repayment plans (consumer proposals) or bankruptcies. Their fees are paid through that process.
Check that it’s a federally regulated trustee otherwise you may be charged a fee up front, Smith cautioned.
READ MORE: A repayment strategy is the quickest path to becoming debt free
The good news in all of this is that credit card interest rates don’t fluctuate with the Bank of Canada rate, Smith said.
Of course, that can change if the Bank’s rates go up by too much.
How much are the increases likely to be? Canadian mortgage rates peaked in the 1980s at just over 21%.
“Unless inflation gets really crazy and continually stays high, I think it might be more like the prime rate getting between 5% to 7%, in the worst case scenario,” Smith said. “If we got to a 7% interest rate, the housing market would just crumble and I think that would create a huge impact on the economy. This is where the Bank of Canada is trying to walk really finely down the edge because they know if they push interest rates too high, the housing market could fall off the cliff and we could see some real problems, like back in the 80s where people just walked away from homes. That part of it, I don’t think the Bank of Canada really wants to see.”
The U.S. Federal Reserve predicted today that its benchmark rate will reach 3.4% by the end of this year and 3.8% by the end of 2023.
Mortgage rates are usually a couple of percentage points higher.
The next Bank of Canada rate adjustment could come on July 13.
“They want to see how the housing market is going to react with these three interest rate increases this year so far,” Smith said. “They want to see how it trickles through the economy and through the housing market before they get too gung ho. It is also dependent on where inflation rates go. That’s going to take another 12 to 18 months before they really get that under control.”
Similarly, it could take that long to see what the half of Canadians who are freely spending their money on travel and consumer goods are going to do.
READ MORE: Half a million passengers faced delays on international flights at Pearson in May
“People with home equity lines of credit or equity in their houses – they might feel they have the money to do those vacations,” Smith said. “But, if they’re doing those vacations on credit, that’s not a good use of your credit, because you’re not getting any value out of it other than the entertainment at the time you’re away.’
Even for those who are better off, it depends on the source of their money.
“Are people using debt to buy stuff or are they actually using savings to buy things?” Smith pondered. “We’re going to have to see how that impacts the economy as a whole because consumer spending is the driver of the economy. If people’s spending habits are pulled back because of the cost of living and how much they’re paying in interest goes up and they have less money to spend, that could reduce the overall economy. We’re going to see the impact of what is happening now in probably six to 12 months or longer.”
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