Now might be the time to think of ways to pay off debt. The much anticipated announcement of an interest rate increase is looming.
Next week, Wednesday July 12 to be exact, the Bank of Canada will announce an increase (if any) to its overnight lending rate. Currently sitting at 0.50%, the consensus is that an increase of 0.25% next Wednesday is more than likely.
(Update: The Bank of Canada did increase the overnight lending rate by 0.25%, so it is now sitting at 0.75% as of July 12, 2017.)
What does a rate increase affect?
Quite simply: the cost of money. When the Bank of Canada’s overnight lending rate goes up, the cost of borrowing money increases. While the major banks can adjust their lending rates at whatever they feel, an increase in the overnight lending rate profoundly affects the cost of money being lent.
Who’s going to feel it?
Anybody borrowing money. From lines of credit, home equity lines of credit, car loans… variable rate mortgages and eventually fixed rate mortgages. When it becomes more expensive for banks to lend money, consumers and their loans will start to feel the pinch. You’ve got to start thinking about paying down some of your debt, if not paying it all off outright.
The era of cheap money could be coming to an end
As you’ll see on the chart below, the Bank of Canada rate has been at record low levels. The anticipated increase next week, if it pushes through, would be the first time in more than seven years that the rate has gone up. This would herald the end of an era of cheap money.
With the cost of borrowing money at historically low levels, the economy has more than thrived. But it has also stimulated certain practices, particularly when it comes to borrowing money. Real estate prices have gone up dramatically, and while not outright contributed to low interest rates, it is certainly one of the factors.
Could this drive real estate prices downward?
If rates go up, and if they continue to go up, mortgage rates will start to increase. This directly affects affordability. And affordability affects real estate prices. The effects of the government’s housing plan on the market has been noticeable, as real estate prices have shown signs of cooling. An increase of 0.25% wouldn’t be catastrophic on the pockets of Canadians. But just as how the government’s housing plan affected the perception of the general public, perception of higher interest rates is what will lead prices to be steady or cool off a bit.
Start paying off your debt
This may be the first of several rate increases. And if the rate increase pattern continues, borrowing money will be more expensive. Your debt will cost more as interest rates go up. So start thinking about paying it off.
We’ve been accustomed to cheap (almost free) money. This has allowed car companies to experience record sales by offering attractive financing options. Real estate prices have gone up due to the low cost of mortgages. Homeowners have used their home equity lines of credits for home renovations, vacations and other spending — without the thought of paying it back.
It’s time to look at your financial position and figure out what it’s going to cost you if interest rates start to go up.
What’s the strategy for buying real estate?
Buyers — if you’re waiting on the sidelines for prices to go down, you may be waiting a while. But as interest rates go up, what you really should be asking yourself is… do you want to pay more for the price of your house at today’s low interest rates, or wait until prices cool off a bit but pay a higher amount of interest?
One thing is for sure — if you sit and wait, you won’t have the advantage of paying down a mortgage and building up your equity. On the flip side, if prices do continue to cool, any advantage of that would be wiped away anyway.
But remember — real estate is a long term investment. Chances are you won’t be selling your home in the next 2-3 years. And who knows what the market will be like when you do eventually sell.