Rising Interest Rates in Canada: What Does it Mean for You?

It’s been all over the news in the last few months—interest rates are increasing in Canada. The Bank of Canada increased interest rates three times in the first six months of 2022, totaling a whopping 2%. But besides all the buzz around interest hikes in the news, what does it practically mean for Canadians? Should you care about rising interest rates in Canada if you don’t carry debt? What does it mean for investing?

These are important questions to talk about because rising interest rates directly impact the financial situation for many Canadians. To tackle some of these big questions, I discussed the impact of rising interest rates in Canada on episode 45 of the Canadian Money Roadmap podcast.

If you’re wondering what these rising interest rates in Canada mean for your wallet, tune into the episode, or read on here.

Rising Interest Rates in Canada: What’s It All About?

The Bank of Canada (BoC) controls interest rates in the country by adjusting what is known as the overnight rate or policy interest rate. You can learn more about that process here.

The main thing that happens when the BoC increases its rates is that your debt becomes more expensive. If you have a mortgage, car loan, line of credit, or any other debt, the interest on your loan will increase.

Example: You carry a $100,000 balance on your home and have a variable mortgage rate. If interest rates are increased by 1.5%, this results in an additional $1,500 per year in interest on your debt.

Depending on the type, loans will behave differently:

·      Variable rate: If you have a variable-rate mortgage, interest rates will quickly increase in line with the BoC increase. This typically increases the amortization, which means you will be paying off your mortgage for a longer period.

·      Fixed rate: Good news—your low rate is locked in. That said, once it’s time to renew, you can expect to pay higher rates.

·      New debt: Any new mortgage, car loan, or other debt will be at the new, high interest rates.

It’s always important to review the terms of your loan and understand the impacts on your interest rates. Make sure to speak with a financial planner or other professional if you have any questions!

Paying Off Debt vs. Investing

With rising interest rates in Canada, the cost of debt is now more expensive. Canadians, alongside Americans and people in most other developed countries, have enjoyed a sustained period of cheap debt. Interest rates have been decreasing since the 1980s and have been at historical lows for the last few years.

And, because of the low interest rates, it was cheap to carry debt. The choice for many, then, was to put spare cash into investments and capitalize on higher returns.

While the rising interest rates are not as high as they’ve been in the past, they mark a substantial departure for most consumers. The difference in interest rates equals real dollars in the bank for Canadians. So, what’s the better way to go? Should you pay off debt or invest?

Yes.

Yes, you should pay off debt and invest! They are both good financial strategies, depending on your goals and timeline. A dollar towards paying a loan on a depreciating asset is vastly different than a dollar in a 40-year investment.

There is also a psychological component to debt, where people are stressed out about carrying expensive debt. Increasing your payments or prioritizing debt repayment over investing can provide some peace-of-mind to you and may therefore be a good option.

A quick caveat here: always prioritize high-interest debt, like credit cards (~20%). Pay that debt down as quickly as possible.

Interest Rates, Stocks, and Bonds

If you’re reading this and one of the lucky people who carry no debt, you might wonder if the rising interest rates in Canada impact you in any way. It’s certainly not as directly impactful but increasing interest rates are still affecting your money through the bond and stock markets.

·      Bonds (fixed-income investments) are impacted by interest rates—as interest rates go up, the value of existing bonds go down. Say, for example, you hold a bond with a 2% return. If interest rates go up by 2%, new bonds could be issued at 4%. So, no one wants those 2% bonds anymore! They need to be sold at a discount, which decreases the value of the bond compared to alternatives. For conservative investors that rely on bonds, this is not a great short-term outcome.

·      Stocks behave differently. Since fixed-income investments have higher rates due to increase interest rates, they become more attractive over the medium or long term. If you can get 3-6% return in a bond with less risk than a stock, why invest your money in something riskier? Thus, higher-risk or higher-value stocks are not attractive with investors and their prices come down, impacting the stock market.

The Way Forward

I’m not going to sugar-coat it—this is a complex topic! Feel free to check out episode 45 of the Canadian Money Roadmap podcast where it’s discussed in depth. But to summarize the main points here… As interest rates in Canada go up, you can expect:

·      Variable interest rates will quickly increase and can significantly impact your mortgage or loan payments.

·      Fixed-rate interest will stay the same until it’s time to renew—rates will then be higher on renewal.

·      New debt will be more expensive than it has been in the past.

·      The conversation about paying off debt vs. investing will shift and require a deeper comparison of expected rates of return to the cost of your debt.

·      Markets will be more volatile because of the impacts on bonds and stocks.

Evan Neufeld is a Certified Financial Planner® professional in Saskatoon, Saskatchewan and offers both investing and fee-only financial planning services.

*Disclaimer: Any numbers or rates of returns are used for illustration purposes only and should not be taken as fact. Note that the information in this article is current to the time of writing but is not guaranteed as up-to-date past then.

This article and accompanying podcast do not constitute personal financial advice. Evan Neufeld is a Certified Financial Planner® professional in Saskatoon, Saskatchewan and provides this Canadian personal finance content for educational purposes to the public. You are welcome to contact Evan to receive personalized fee-only financial planning or investment portfolio management.