Friday, February 25, 2022 / by Mario Daniel Sconza
Financial Friday #100: Where are Rising Interest Rates Going to Hurt Most?
The Bank of Canada (BOC) meets next week for the second of eight interest rate announcements scheduled for 2022. Interest rates were left unchanged at the first round in late January, but it is expected that they will begin raising rates starting next week, possibly with a 0.25% or even 0.5% hike. Either way, it doesn’t sound like a lot and depending on your debt situation you may hardly notice.
However, rising inflation combined with a strengthening post-pandemic economy gives both reason and opportunity to raise rates more aggressively. A hike next week may only be the start of several increases throughout 2022. Keep in mind that the BOC dropped rates by a whopping 1% in just a few weeks at the height of the pandemic in March of 2020. It could be that interest rates are 1% or even 2% higher by this time next year, and that would definitely not go unnoticed!
One thing to clarify is that most variable rate loans are based on the “prime rate”. The prime rate (currently 2.45%) is different than the BOC overnight rate (currently 0.25%) and is determined by the major banks. They are different, but the key takeaway is the prime rate normally moves in lockstep with any changes to the BOC rate, usually within a few days.
Now that we have the background knowledge out of the way, just how will future BOC rate hikes affect various types of debt?
1. Variable rate mortgages
The percentage of Canadians holding a variable rate mortgage surged in 2021 and now stand at about 50%. Any rise in BOC rates is usually met with an equal rise in a variable rate mortgage, so the impact will be almost immediate. If rates rise 1% over the next year, a $500K mortgage payment will increase by over $200 month.
2. Home Equity Line of Credit (HELOC)
HELOCs usually have a variable interest rate that will rise in conjunction with any BOC rate hikes. If you are paying only the interest on your HELOC balance, any rise in rates will have a very direct and significant effect on how much you have to pay every month. A $100,000 balance carried on your HELOC will cost you about $20 more each month for every 0.25% increase by the BOC, so you could easily be looking at an extra $100 monthly a year from now.
3. Credit card debt
Credit cards usually have fixed interest rates and you would have to dig into your card-holder agreement to see the details of how the rate can be changed. However, credit card rates are already so astronomically high that it is unlikely you would even notice a 1% increase! Our advice is to attack any outstanding credit card balance asap. Paying the minimum each month is futile and only keeps your creditors at bay. It requires over 10 years of minimum payments to eliminate a $1000 balance (at 20%) and will cost you another $1000 in interest charges!
4. Personal lines of credit
There are fixed and variable rate options out there. If you went for that lower variable rate when you signed the agreement, expect to pay more on any outstanding balance.
5. Car loans
Car loans can be either fixed, variable, or sometimes have a combination where they change to a variable rate after a few years. You will need to check your loan agreement for any variable interest portion to see if your payment is going up…. in addition to those skyrocketing gas prices!
6. Student loans
The default choice for Government of Canada student loans is variable interest "at prime" with a fixed rate option at "prime + 2%". The point is mute right now as interest charges are currently suspended, but variable rate student loan holders will see a significantly higher payment when interest charges resume in April of 2023.
In conclusion, the bad news is that you may soon be paying more interest each month, but the silver lining is that you may become more aware of just how much your debt is costing you. Not all debt is bad, but the cost can vary greatly and you need to make sure your debt repayment priorities are in order.