Interest Rates Are Rising: How To Manage Them & Your Debt
If you are a Canadian under the age of 50, you were not yet an adult the last time mortgage lending rates in Canada sat at over 10%. In 1981, the Bank of Canada’s overnight interest rate spiked to an astonishing and alarming 19.64% – which meant that lending rates for mortgages and credit cards rose even higher than that. Fortunately, that spike was temporary – but mortgage rates remained over 10% on average throughout the 1980s.
Are we heading for similar times?
Higher Interest Rates: Where are We Heading?
Since 2009, the Bank of Canada’s overnight interest rate has been under 1% – often as low as 0.25%. The chattered banks’ “prime rate” – the rate they offer their best customers – has stayed below 3%. Mortgage rates for customers with good credit ratings are typically near the prime rate.
For older Canadians with mortgages or other consumer debts, these historically low-interest rates have brought an unexpected windfall of savings on debt servicing.
However, younger Canadians just becoming consumers or entering the housing market have come to expect low mortgage and lending rates. For them, rising interest rates could have unexpected consequences – barring them from the housing market, or stranding them with unexpectedly high bills that their incomes cannot cover.
Why are the rates rising?
World money markets, supply chains, and all forms of commerce have been affected by the COVID-19 pandemic. Similar to the cost of most commodities, interest rates rise when the demand for lending products begins to exceed the supply. As the pandemic has eased, money is on the move again and the demand for loans on all levels, from individual consumers to large governments, is high.
Inflation, too, can affect interest rates, and inflation is on the rise. Inflation – another phenomenon older Canadians remember from the 1970s – is the erosion of the value of a currency. Consumers notice inflation when it causes higher prices for goods. A lender will require a higher interest rate during an inflationary period to compensate for the value their money loses while it is on loan to a customer. The Bank of Canada also moves its interest rates up as a tactic to fight inflation.
No matter how you slice it, today’s financial scenario places great pressure on consumers.
The “Miracle” of Compound Interest
Spoiler: it’s only a miracle if you are an investor or lender!
Compound interest, which is simply interest that accrues on both the “principal” (the original amount of your loan) and on the accumulated interest itself, can cause an unexpected debt spiral for consumers. Compound interest is the normal way of calculating interest on most consumer accounts.
What compound interest means to a consumer is that you may find that you are paying more interest every year than anticipated. Add to this rising interest rate, and you could find yourself out of your comfort zone very quickly.
Strategies to Plan for Higher Interest on Your Debts
Forecasters predict that interest rates for Canadian consumers will continue to rise. Although the peaks of the 1980s are not expected to return, borrowing will not be as easy as it has been for the past decade – and it will be more expensive.
It’s time to strategize, in order to meet your debt-reduction goals and avoid being overwhelmed with bills.
Target higher-interest accounts by making extra payments
This strategy is a must-do for those with credit accounts they are paying off. It may seem obvious, but when sorting through your bills, it’s easy to lose track of which accounts have the higher interest rates.
It’s time to look at your bills a little closer!
You’ll make much quicker headway on debt reduction if you prioritize making extra-large payments into your higher-interest accounts, whether they are large accounts or small ones.
Here is an example: it may be wisest to make extra-large payments into certain credit cards, rather than paying extra into your mortgage or home equity line of credit (HELOC). This is because mortgages and HELOCs tend to charge less than 10% per year in interest, whereas many credit cards charge well over 15%.
If you like to do the math, sit down and calculate how much interest you pay per month, in total, on all your debts. Then look at where the bulk of that interest total comes from. Paying extra into the higher-interest accounts will pay off with money in your pocket!
Reduce your expenses: make a budget!
This tip goes hand-in-hand with the last one about tackling higher-interest accounts. Once you’ve checked where your money is going in interest charges, have a good look at where it’s going in monthly expenses and extras.
This is especially important if you are already carrying expensive debts that you’d like to pay off quicker. Why? Because if you can reduce your expenses, you’ll have more money to pay towards those debts!
First, make a list of your monthly sources of income. Use an average if some of your income is sporadic.
Then, make a list of expenses. This list is likely to be longer. Include housing expenses (rent or mortgage), food, utilities, internet/phone/entertainment, insurance, and other monthly bills. Don’t forget to include property tax or income tax if you pay those, calculated to a monthly amount.
Then compare the lists. If your monthly expenses are greater than your monthly income, you need to make some adjustments right away, since it is likely you are living off your credit to some extent. But even if this is not the case – and we hope it isn’t – examine your list of expenses closely. Consider what you might be willing to do without, in exchange for having more money to pay off your debts.
If you can’t eliminate any expenses from your list, consider how you can economize. Buying certain items such as household paper products in bulk may seem like a large outlay at the time, but can save money in the long run.
Seek lower-interest-rate products and lock them in
Don’t ignore this step, as it can help you reach your debt-reduction goals without sacrificing anything you’d like to keep.
Is your mortgage up for renewal soon? See your banker to check how soon you can make a new deal before interest rates rise further.
Do you have credit cards? Often the company will be willing to lower your interest rate – it’s well worth giving them a call to ask (if you are a good customer, they won’t want to lose your business). The larger banks usually have several versions of their VISA or MasterCard – they may be willing to move you to a lower-interest-rate version.
If the interest rates on your credit cards are on the high side, check online for better rates from different banks and credit companies. But be careful – some offer an initial low-interest rate on account transfers, only to raise the rate a few months later (read the fine print).
Struggling with Debt? There’s Help – Talk to a Licensed Insolvency Trustee
Do you struggle with debt that you just can’t seem to shake? Are you often late paying your bills? Is anxiety over your debt affecting your sleep or your well-being? Are creditors calling you or sending unpleasant letters?
If you answered yes to any of these questions, you should make a free first appointment with a Trustee in Bankruptcy in Canada (actually called a Licensed Insolvency Trustee (LIT). A LIT can review your situation and let you know your options. You may just need help with budgeting, you may benefit from advice on debt consolidation, or you may need to take a look at a consumer proposal or bankruptcy as your best solution.
Your first appointment with an LIT is free of charge, confidential, and no obligation. If you’ve been feeling financial stress, you’ll feel much better knowing that there are practical options available. So don’t hesitate – contact a Licensed Insolvency Trustee in your area today!