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Rising interest rates and debt: what you need to know

No matter where you are on the pay grid or what your pension income is in retirement, rising interest rates are making everyone’s debt load more expensive to carry.

In fact, according to the latest quarterly MNP consumer index survey, 43% of Canadians are already feeling the pinch of higher interest rates—with 51% actually fearing that rising rates could affect their ability to pay down debt.

With the key lending rate now at 1.5% after the latest Bank of Canada (BoC) rate hike on July 11, it’s time to start reviewing your budget. Particularly if you hold one of the nearly 50% of outstanding mortgages in Canada that have interest rate renewals within the next 12 months.

What does a rate hike mean for current fixed-rate mortgage holders?

If you have a fixed-rate mortgage, you can relax for the time being. Just keep in mind that depending on how soon renewal time is for your mortgage, rates will most likely be higher than the one you locked in at—which could impact your monthly budget.

For example, if the remaining balance of your mortgage is in the ballpark of $200,000 to $400,000, and there is a 1-2% increase from your current rate after renewal, your mortgage payments could cost you $200 to $400 more per month.

While rising interest rates are a reality of the ups and downs of an ever-changing market, there are ways you can get ahead of rising rates before your own mortgage renewal time. Click here for 3 simple strategies to pay your mortgage off 5 years faster.

If you have a variable-rate loan and/or mortgage, you’re already paying for the latest rate increase.

While the upside to variable-rate loans is that interest rates tend to be lower than those with a fixed rate, the downside is that with every BoC rate increase, you instantly pay more for those variable loans and mortgages each month.

To put the latest rate increase into perspective, let’s say you have a $400,000 variable- (or ‘adjustable’) rate mortgage amortized over 25 years, and that your variable rate is 2.35%.

Your monthly mortgage payment would have been $1,762 prior to the July 11 rate hike. After the hike, your variable rate would jump from 2.35% to 2.60%, and your monthly mortgage payment would increase to $1,812—a difference of $50 a month, $600 a year, and $15,000 over the course of 25 years.

47% => the percentage of Canadians who do not believe they will be able to cover all living and family expenses in the next 12 months without going into debt, according to the latest quarterly MNP consumer index survey.

How do rising interest rates impact first-time home buyers?

Besides having to pay higher rates than those who entered the housing market a few years ago when rates were blissfully low, there’s a new thing called the ‘mortgage stress test’ to factor in.

A refresher on the mortgage stress test

  • It was introduced by the Office of the Superintendent of Financial Institutions on January 1, 2018 as a way for home buyers to prove they can afford higher interest rates.
  • This means buyers who apply for uninsured mortgages with a down payment of 20% or more, or those buying homes worth $1 million or more, will have to be ‘stress-tested’.
  • The test aims to show which home buyers can afford a mortgage either at the 5-year average posted rate, or two percentage points higher than the bank/brokerage rate (whichever one is higher).
  • Since the stress test came into effect, buyers need an average of $28,750 more than they did prior to Jan.1, 2018 to qualify for a mortgage (according to Mortgage Professionals Canada).

Every time the BoC raises its key lending rate, the benchmark rate for the mortgage stress test also goes up—affecting whether or not potential home buyers get approved for the mortgage they want.

Here is the $64,000 question: how do you get ahead of rising interest rates when it comes to your debt?

1. Start by paying down debt of the ‘variable’ kind.

Interest rates are steadily climbing, with more rate hikes expected to come over the next year or two. If you have a mixture of fixed- and variable-rate debt tied to prime, consider creating a plan to actively pay down your variable-rate debt first. This will reduce the immediate impact that each rate hike will have on your finances.

However, if your fixed-rate debt load is substantial (such as high-interest credit cards), you may want to focus on paying that down first, depending of course on how much you owe and how high the fixed rate is.

2. You should consider converting from a variable to a fixed rate.

If rising interest rates have your stress levels rising, you may want to consider fixed rates (and the peace of mind that they provide), particularly since the financial forecast calls for another four rate increases at least, over the next two years.

When it comes to converting from variable to fixed, however, be aware of the conversion rate offered by your lender. This is the cost of switching, and tends to be higher than what new borrowers would pay.

To decide whether or not it makes financial sense to make the switch from variable to fixed:

  • Evaluate the conversion rate being offered by your lender
  • Factor in the number of years left in your current term, and any further interest rate hikes projected within that time frame

Also be aware of any term limitations.

When converting to a fixed rate, most lenders require you to choose a fixed term that’s at least as long as the term remaining on your variable-rate loan. Furthermore, some lenders may only let you lock into a 5-year fixed term, which is fine if you’re looking for that long-term commitment. However, keep in mind that should you need to break the mortgage before the five years are up, you may have to pay additional costs. There may also be refinance restrictions. So be sure to ask for full disclosure on all of the ‘fine print’ and ask for everything in writing.

3. ‘Stress-test’ your finances by conducting a future budget exercise.

While the stress test is now a mandatory exercise in order to qualify for a mortgage, the concept of ‘stress-testing’ your finances can also be used as a way to gauge how future rate hikes could potentially impact your cash flow or your ability to pay down debt. Playing around with a budget calculator is the easiest way to do this. Use it to estimate how much financial room you have to accommodate increased debt payments that could arise due to further escalating interest rates.

Do rising interest rates have you feeling nervous? Call on Educators Financial Group for a little peace of mind.

From a sound financial plan to help you conquer debt and save more efficiently, to smart borrowing options at rates offered exclusively to education members and their families—let us help you achieve the financial future you always dreamed of.

Have one of our financial specialists contact you to put your financial plan into motion.

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The information provided is general in nature and is provided with the understanding that it may not be relied upon as, nor considered to be, the rendering of tax, legal, accounting or professional advice. Please ensure to consult your accountant and/or legal advisor for specific advice related to your circumstances. Educators Financial Group will not be held responsible or liable for any losses, costs, damages or expenses incurred by reason of reliance as a result of the aforementioned information. The information presented was obtained from sources that are believed to be reliable. However, Educators Financial Group cannot guarantee their completeness or accuracy.

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