On June 7th, 2023, the Bank of Canada (BoC) announced it was raising its interest rate to 4.75%. This announcement comes after a short pause in hikes.
Why is this happening?
The COVID-19 pandemic changed the economic landscape in 2020. To boost the economy, the Bank of Canada lowered its policy interest rate to 0.25%.
Over the last year, since January 2022, the BoC has raised its policy interest rate by 450 basis points. The BoC is raising rates to attempt to rein in high inflation.
In June 2022, inflation reached a 39-year high of 8.1%. Though inflation has slowed in the months since, it remains high. Too high for the Bank of Canada, that hopes to slow the economy.
Let’s look more closely at how policy interest rates work and how they can affect your finances.
What is a policy interest rate?
The policy interest rate is set by a country’s central bank, such as the Bank of Canada. The Bank of Canada’s policy rate serves as a reference point for the rates that the banks charge to consumers.
These rates affect the interest rates you pay on:
- your mortgage,
- your home equity line of credit, and
- other types of credit.
Worried about higher interest rates? Don’t have a plan?
An advisor can help you.
What do rate increases mean for homeowners?
Are you planning on renewing your mortgage, buying a home or taking out a loan? Ask yourself, “Can I handle that debt or that new loan at a higher interest rate than I’m receiving today?”
- Fixed-rate mortgage
If you’re renewing your fixed-rate mortgage soon, higher interest rates could increase your monthly payments. This increase could have an important impact on your budget 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.
- Variable-rate mortgage
If you have a variable-rate mortgage, recent rate increases will affect you differently. Your payments probably increased, to mirror the prime rates.
- Stress test now harder for some homebuyers
Are you 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.
All of the recent increases will likely make the stress test more challenging for some homebuyers.
What do higher interest rates mean for savers?
When interest rates go up, so do consumers' expectations for interest rates on savings accounts. Recent hikes 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.
How to prepare for an interest rate rise?
The steady hike in rates since January 2022 have changed the landscape for those taking out a loan. Especially for homeowners who’ve enjoyed years of historically low rates. Economists are divided as to whether more hikes are in the cards. Whatever the economic forecast, it’s never a bad idea to:
- Make a budget and stick to it as best you can.
- Build an emergency fund for hard-to-predict expenses.
- Make a financial plan with your advisor. When life changes, remember to update your plan.
- Try to limit your spending and chip away at your debt. That way, any rate hikes have the least possible negative impact on your finances.
- Inflation: What it means and how to protect yourself
- What do you do when the stock market drops?
- What is a recession and what does it mean for you?
This article is meant to provide general information only. Sun Life Assurance Company of Canada does not provide legal, accounting, taxation, or other professional advice. Please seek advice from a qualified professional, including a thorough examination of your specific legal, accounting and tax situation.