The Bank of Canada is hinting a hike in the overnight lending rate is coming soon. This move will affect the payments on variable mortgages, lines of credit or any debt connected to the floating rate.
Short-term overnight rates have been stalled at 1 per cent since September 2010 and the Bank of Canada knows they can’t stay there for too much longer. It’s because Canadians continue to take on more cheap debt and inflationary pressures are starting to creep in. More recently the Central Bank noted improved prospects for both the global economy and ours. Indicating Canadians could handle a higher cost of borrowing.
If you’re worried about your ability to service debt in a higher interest rate environment, there are plenty of steps you can take right now to prepare.
Fix your Mortgage Rate
If you’re on a variable rate mortgage you may be able to lock into a fixed rate without any costs. Talk to a mortgage expert to see what your options are. With your rate fixed for five years you can more easily budget and manage your money over that time.
Start Paying More Principal Down
The smaller your debt is the easier it will be to handle. If you’re carrying a large mortgage or a substantial line of credit, start paying down your loan as aggressively as possible. Every cent you put in today will save you money down the road, especially when rates start to rise and that money gets more expensive to carry. This is true even if your mortgage term is fixed, because you will be better prepared when it comes up for renewal.
Don’t Take on Any New Liabilities
With interest rates so low, there may be a temptation to take on more debt. But if you’re already carrying a high load, this is not the time to start major home renovations or buy a new car. If possible start saving for those new purchases so you can avoid paying any interest at all. This is a good habit to have no matter where interest rates stand.
Say NO to an Expensive Home
If you’re out shopping for a mortgage, don’t take on the maximum your bank is offering. There is an easy method to figure out what you can afford. Calculate your monthly household income after taxes. Ideally your mortgage payments should represent 25 to 30 per cent of that number. Aim to have your payments around 25 per cent for now so they won’t exceed that comfortable amount when rates rise. If your ratios are too high then you need to find a less expensive house.
Base your Payments on a Higher Rate
Make the lifestyle changes you need to cut back on your spending now. Don’t wait until rates go up to see where you can save. I recommend paying your mortgage at a rate of at least 5 percent. This will help you adjust your budget early to handle those higher payments later.
Stay Invested in Canada
Higher interest rates will mean a stronger Loonie. If you’re looking to convert any cash to U.S. dollars holding off for a year could save you a great deal of money. This is especially true for anyone buying real estate in the U.S. My advice, start saving your cash in Canadian dollars, you could get a better exchange rate at the beginning of next year when rates are expected to rise.
Don’t Forget About “Normal” Conditions
The Bank of Canada likes the overnight lending rate to be around 6 per cent. Meaning in normal economic times commercial banks will offer a prime rate closer to 8 per cent. Don’t worry that isn’t happening anytime soon. But it’s important to keep in mind that in the last 30 years Canada’s interest rate has fluctuated dramatically. In 1980 it reached an historical high of 18 per cent and a record low of 0.25 per cent in April of 2009.
Who is Most Vulnerable
Anyone holding an adjustable or variable rate mortgage will be affected, as the banks will raise prime from the current level of 3 per cent. Also if you have a floating rate on your personal debt you should also be aware of the higher cost of borrowing and what that means to your budget. A hike is still months away and taking these appropriate steps now will protect you and your family from rising costs.