Borrowing interest rates have been historically cheap for a few years now (since the Bank of Canada slashed the central rate back in post-recession 2010). And as soon as they dropped, a variety of pundits began predicting the calamity that will ensue for borrowers once they begin to inevitably rise. While none of these predictions have yet to come true, the further we recover from the 2007 global financial crisis, the sooner rates will rise.
A recent flurry of positive economic development in the U.S. has breathed new life into the speculation; QE there will end this month, and new rate projections have been released that have raised economists’ eyebrows. The median projection for U.S. rates for the end of 2014 is an increase of 1.375 per cent, and up to 2.875 per cent by the end of 2016 – a big jump from the current 0.25 per cent. And, since the Bank of Canada generally follows the lead of our American neighbours, we too could be in for some higher borrowing costs sooner than anticipated.
Also read: Are We Ready for the End of QE?>
What, Me Worry (About My Mortgage)?
How could an interest rate increase affect you? Say you’ve just locked into a five-year fixed mortgage at less than 3 per cent. Congratulations. On a $350,000 mortgage your payments should be about $1,600 a month. But what happens if interest rates jump over that five-year period and the best rate you can get at that time doubles to 6 per cent? Even if you’ve managed to aggressively pay of $50,000 of the principal, your monthly payments would go up to around $2,000. Will you have an extra $5,000 a year on hand to meet those payments?
Can you afford a higher mortgage rate? Check out our Mortgage Payment Calculator>
And what if the rates skyrocketed? You don’t have to go that far back – 1981 to be precise – to a time when the average mortgage rate in Canada exceeded 20 per cent. The monthly payments on $300,000 at 20 per cent are almost $5,000.
Relax, we’re not saying that they go up that high. But they will go up. Here are some tips to help you plan for inevitable.
Cut Back on Spending and Credit
The easiest way to save money is to spend less of it. The first step in doing that it to track your spending. On everything. Set up a simple Excel spreadsheet and, for three months, enter every penny you spend on: your mortgage payments, utility bills, groceries, concert tickets, iTunes downloads, beers at the pub, takeout coffee… if you spend money on it, make note of it. After three months, you’ll have a list of columns that may surprise you. One $5 coffee every workday will add up to more than $300 over three months. Paying more for cable or satellite than you realized? Need to cut back on your pub nights? By tracking your spending you be able to spot areas where you can cut back and, as you continue to do it, see how each little change in your spending habits adds up.
Also read: The Latte Effect>
Bank On It
Setting aside a nest egg to help buffer and future financial shortfalls is smart planning. But one downside to the low interest rates is that any money you may have in your savings account is earning next to nothing in interest. In fact, 37 per cent of respondents in a recent RateSupermarket.ca social media poll said today’s interest earnings actually discourage them from trying to save. And it’s no wonder – the interest rate on some bank’s savings accounts is as low as 0.02 per cent, meaning you’d earn a whopping 20 cents for leaving $1,000 in your account for a year, less any fees.
Earnings may be dismal, but fortunately for consumers, some banks are seizing the opportunity to be competitive. By shedding the cost of bricks-and-mortar buildings, one of the things online-only banks are able to offer is higher than normal interest rates on savings accounts. Tangerine (formerly ING Direct) has a promo on right now offering 3 per cent interest on their savings accounts.
Penelope’s Pick: Credit unions also tend to offer higher interest rates on savings. A great option is the Meridian Good to Grow High Interest Savings Account (available in Ontario), which features a 1.75 per cent rate, charges no fee and doesn’t require a minimum balance. Click here to learn more>
Don’t Penalize Yourself
The number one rule for saving money: Don’t waste it on interest and penalties for overdue bills. Credit cards, particularly ones issued by retailers, charge extremely high interest rates (as high as 30 per cent in some cases). And if you pay anything less than your minimum monthly balance, the interest is backdated to the date of your first purchase on the statement. For the occasional cash shortfall, you should get yourself set up with a line of credit to pay your balance off in full. If you’re regularly short of your monthly needs, it might be time to meet with a credit counselor for help developing a savings plan.
Downsize to Avoid Big Debt
If you’re already finding yourself stretched to meet your monthly bills, perhaps you should consider downsizing your property. After all, you’re better off doing it now while most Canadian real estate markets are still hot, than after interest rates do start to rise and other similarly strained Canucks end up foreclosing on their homes, leading to a glut of homes on the market.