It’s time to prepare for higher interest rates

Opinion

Hey there, time traveller!
This article was published 29/01/2022 (425 days ago), so information in it may no longer be current.

Do you have any variable rate debts?

If so, you had a reprieve this week when the Bank of Canada decided to leave its overnight lending rate at 0.25 per cent, a historic low that was reached shortly after the pandemic began.

However, with the last 12 months’ inflation rate at 4.8 per cent and an estimated 75 per cent of economists calling for a rate increase, expect rates to rise in the next month or so, unless there is a significant drop in the next inflation report.

Anyone with variable-rate loans might want to look at their options for fixing the interest rate at a slightly higher level for an extended term. This will lock in today’s rates and ensure predictability of payments going forward.

The most common variable-rate debt is a line of credit, where the interest rate is based on the prime rate or stated lending rate of a bank or credit union. The interest rate you pay will change as official rates change.

The largest debt that most people carry is a mortgage. Mortgage payments are typically the largest monthly payment for anyone who had to borrow to buy a home. With a variable rate mortgage, an increase in interest rates may mean an increase in monthly payments and a big effect on the family budget.

On the other hand, some mortgage agreements maintain a fixed payment when rates go up, but less of the payment is allocated to principal and more to interest. That means you pay off less of the loan during the current term.

The challenge, of course, is deciding how much extra you want to pay for certainty. Since the general expectation is that rates will rise, the interest rates available on longer term mortgages have already risen, even while variable rates have stayed low.

For example, variable mortgage rates are generally between 1.55 per cent and 1.75 per cent this week. Locking in for five years will cost you around 2.75 per cent, assuming you have good credit, and you negotiate for a better rate than posted.

On a $200,000 mortgage, locking in for five years might raise the monthly payments by about $120, but would provide certainty for those five years.

If the variable rates rise by more than one per cent over the next couple of years, then the locking in would look like a wise decision.

So, how much will rates rise over the next one to two years? Sorry, I can’t tell you that (and, of course, you wouldn’t want me to tell you anyway, as that would make the decision too easy…).

But both the Bank of Canada and the U.S. Federal Reserve have signalled they will start raising rates in March. In the U.S., the markets are said to be anticipating four increases in 2022.

Those indicators suggest that anyone with a variable rate loan should do some deciphering and budgeting. Don’t ignore the issue.

If you are shopping for a home now, definitely get your mortgage pre-approved (which you’ve probably already done) and make sure the approval includes an interest rate guarantee for at least 90 days. You can decide on the term when your purchase is complete, but at today’s rates.

As with all financial (and life) decisions, there are always unknowns, but careful thinking and planning almost always gets you ahead.

Dollars and Sense is meant as an introduction to this topic and should not in any way be construed as a replacement for personalized professional advice.

David Christianson, BA, CFP, R.F.P., TEP, CIM is recipient of the FP Canada™ Fellow (FCFP) Distinction, and repeatedly named a Top 50 Financial Advisor in Canada. He is a Senior Wealth Advisor and Portfolio Manager with Christianson Wealth Advisors at National Bank Financial Wealth Management, and author of the book Managing the Bull, A No-Nonsense Guide to Personal Finance.