How to prepare for higher interest rates
As the Bank of Canada signals it’s preparing to raise rates, take steps to cushion your portfolio.
They say there are only two certainties in life, death and taxes. We can add a third to that list. When they are at a historic floor level, interest rates will eventually rise.
Central bankers in Canada and around the world lowered interest rates to encourage lending and stimulate their respective economies after the financial collapse in 2008. Now, it's 2010 and in much of the developed world, the situation has improved. According to the Organization for Economic Co-operation and Development, the Canadian economy is expected to substantially outpace all other G7 countries for at least the first half of this year. That surge, combined with stronger than expected inflation should lead the Bank of Canada to start raising rates before any other G7 economy. Mark Carney could lift rates as early as June.
Each country is at a different stage in the recovery process and has a different pace of economic growth. As a result, the inflation risks are different. Monetary policy and the need to remove stimulus measures and raise interest rates will differ from country to country.
What does all this mean for you?
Interest rates affect most Canadians via their mortgages. Variable rate mortgages are based on your financial institution's prime rate. This in turn is closely linked to movements in the overnight lending rate set by the Bank of Canada. If it rises, you'll likely end up paying more as interest. I recommend bi-weekly or even bi-weekly accelerated payments to pay off your mortgage faster and mitigate the effect of rising rates. Ask your financial institution if they can structure your mortgage as partly fixed and partly variable. This may require setting up a Home Equity Line of Credit.
Consumer credit in Canada has quadrupled since the beginning of the 1990's (from $93 billion to $408 billion). Mortgages have almost tripled over the same period (from $255 billion to $896 billion). In other words, we owe more than ever before. In 1990, our household debt-to-personal disposable income ratio was 90 per cent. By the end of 2009 that number jumped to 146.2 per cent. In other words, for every $100 of disposable income in our pockets, we owe $146.20. Lower interest rates have made servicing that debt manageable. But as interest rates rise, we'll feel the pinch. If you're only making the minimum payments on credit cards, start paying down more aggressively. Cut discretionary expenses and pay down all non-essential debt. Also consider bringing together all of your high interest debts, such as credit cards and unsecured lines of credit, into one consolidated lower interest loan.
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The one luxury that I would pay extra for when looking for a home:
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- An indoor swimming pool or hot tub
- Heated bathroom floors (no more cold feet!)
- A heated driveway … No more shovelling!
- A home cinema room