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Financial planning tips

July 19, 2017

What the interest rate hike means for Canadians

The impact of an interest rate hike depends on whether you’re a borrower or a saver — but chances are there will be more to come, so be prepared.

On Wednesday, July 13, 2017, the Bank of Canada raised interest rates for the first time in 7 years, by 25 basis points (100 basis points = 1%).

The overnight rate, which is the rate banks use to lend each other money, is now 0.75% and the deposit rate is 1.5%.

So what do these new figures mean for you? Essentially, the Bank of Canada (BOC)'s interest rate acts as a benchmark for the rates that banks give consumers. Following the hike, the Big Six banks increased their prime interest rates to 2.95%, up 0.25 basis points from 2.7%. This rate, in turn, affects the interest rates on your mortgage, home equity line of credit (HELOC) and other credit products.

According to a July 2017 survey by MNP LTD, a personal insolvency firm, 45% of Canadians and 48% of homeowners are "concerned about the impact rising interest rates will have on their finances." And in general, most Canadians are feeling pessimistic about their debt loads. For that reason, many experts such as Sun Life Global Investment’s chief investment officer, Sadiq Adatia, are critical of the Bank of Canada’s latest move.

“When you look at an economy and see that it is doing well, you should dig deeper and see why it’s doing well,” says Adatia. “If you say ‘I’m a little bit surprised why these areas are doing well,’ then you should be cautious.”

The latest data on inflation (May 2017) pegged the Consumer Price Index at 1.3%. In a press release on the BOC’s interest rate decision, the bank cites “soft inflation readings” and Canada’s strengthened economy as reasons for the hike.

Adatia notes that Canada’s economy has grown stronger in 2017 and seems to be recovering from the low oil prices seen in 2015-2016. But he is concerned the hike may curb that growth and increase household debt at a time when many Canadians are grappling with enormous debt loads. “Why just not pause and let the economy just do its own thing,” asks Adatia. "And if you see things overheating, then raise rates.”

What the increase means for homeowners

Typically, an interest rate hike after a long period of stability signals subsequent increases, so if you are planning on renewing your mortgage, buying a home or taking out a loan, you should ask yourself, “Can I handle that debt or that new loan at a higher interest rate than I'm receiving today?” says Adatia.

If you have a fixed-rate mortgage that will be renewed shortly, the new interest rates could increase your monthly payments, especially if your new amortization period is short and the balance on the mortgage at the time of renewal is substantial. For a precise indication of how your mortgage payments could change, contact your mortgage broker or lender.

If you have a variable-rate mortgage, this latest increase will affect you differently. You will likely see your payments increase within the next month, so that they mirror the new prime rates.

Stress test now harder for some homebuyers

If you’re buying a new home, federal rules require you to pass a stress test if you’re making a down payment of less than 20%. The stress test requires borrowers to prove they can make mortgage payments at whichever rate is greater – the rate offered by their lender or the 5-year fixed rate set by the Bank of Canada. This increase means that the stress test will be slightly more challenging for some homebuyers.

What does the interest rate increase mean for savers?

When interest rates go up, so do consumers' expectations for interest rates on savings accounts. This hike may mean slightly higher rates on savings accounts and guaranteed investment certificates (GICs) down the road. The banks aren’t obligated to raise savings account interest in proportion to borrowing interest rates, but competitive pressures may eventually result in a rise.

The bottom line

While this latest hike is a significant move, it's important to note that interest rates are still at historically low levels. In the early 2000s, prior to the recession, the overnight rate was 2.75%, which is 2 full percentage points higher than the current interest rate. That said, it is very likely that the Bank of Canada will continue to raise interest rates in the near future, notes Adatia. “I would be baffled if I saw multiple interest rate hikes in 2017, but they clearly must be thinking that, because why start the process now if you’re not going to raise the rate again in the near future?” he says.

So as the Bank of Canada adjusts interest rates, spend prudently and chip away at your debt, so any rate hikes have the least possible negative impact on your finances.

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