WHAT HIGHER INTEREST RATES MEAN FOR CANADA

The Bank of Canada Prime interest lending rate is the de-facto basis rate for financial products such as variable-rate mortgages, home equity lines of credit and other loans,  So- yes, it’s a big deal!  

 By Max Singh

The Bank of Canada had hiked the interest rate for the first time in seven years not once, but twice in the summer of 2017.  The latest decision In September, which follows a first hike in July, could be just the second in a spate of rate increases to come, according to some economic experts The Bank’s two rate hikes this summer effectively wipe out the significant two cuts it introduced in 2015 in response to the global oil-price shock. The increase although marginal does now have an effect on Canadian homeowners, consumers and business’s. The Bank of Canada Prime interest lending rate is the de-facto basis rate for financial products such as variable-rate mortgages, home equity lines of credit and other loans, so – yes. It’s a big deal!   Soon after the Bank of Canada’s announcement, all five major Canadian banks announced they were increasing their prime rates —to 2.95 per cent from 2.7 per cent.

Why have interest rates risen?

The rise in rates have a string of reasons. Recent Statistics Canada info reveals the economy expanding at an unpresented annualized rate of 4.5 per cent in the April to June period leading to fears of inflation and an over-heated economy. By raising interest rates the bank of Canada- in line with the U.S. banks hope to curtail inflation. In Canada, the over-heated real estate market is one sector that has caused concern for the government and there are hopes an interest rate hike can contain and prevent a housing bubble that would decimate many Canadian’s net worth and financial future.

How do interest rate rises affect people? 

Canada have been used to a culture low borrowing interest and credits rates for a number of years now and as a result Canadian are some of the most overleveraged debtors in the world, with worrying levels of home and personal debt. If you are: a homeowner with a mortgage, Home equity line of credit, or a car owner with payments, or a student with debts to pay, or simply carry a balance on your credit card, or have any type of loan you will be affected as interest rates rise and the cost of borrowing goes up.

The good

Financial expert say the increase in the interest rate will provide greater incentives to Canadians to save more as the higher interest rate will offer extra returns for depositors in banks. However, most canny investors, and savers, say the banks derisory interest rates offer little compared to investing money in property, stocks or shares.  Housing experts say higher interest could help stabilize Canada’s severely over-heated property price boom and prevent the possibility of a real estate boom and bust bubble. The higher borrowing, particularly on credit cards and line of credit, may also force consumers to be more financially prudent and not overextend themselves on spending on goods and services, and purchase less on credit

The bad:

Most importantly for Canadians with their obsession with property, the higher interest rate will lead to an increase in mortgage rates. This will make it more expensive and, consequently, more difficult for existing homeowners to pay their mortgages.  Also, the higher mortgage rate may deter new home buyers from buying in or trading up property, as carrying a mortgage becomes more expensive. Some experts fear a declining property market may lead to a slump and bubble as real estate price decline and people go “underwater” (Having a property worth less than its outstanding mortgage). Higher borrowing costs may also deter consumer spending, leading to less demand for goods and services- not good for the economy.

Who does it affect?

HOMEOWNERS

Canadians with variable-rate mortgages, also known as adjustable-rate mortgages, will immediately feel the increase in the interest rates as they are converted to the new rate. Those locked into five years fixed rate mortgages can wait it out until their mortgages come up for renewal.

BORROWER WITH LINE OF CREDIT

Homeowners who use their homes as a source of cash by borrowing against their home equity will now owe more now that interest rates have risen, as those loans are often variable rate.  Canadian borrowers with Home Equity lines of credit (HELOC) will also feel the pinch as HELOCs are linked to the Bank of Canada’s prime rate.

STUDENTS

Do you have a student loan? Although Government student loans don’t require payment until six months after leaving education establishments, they do for now, accrue interest with either fixed or variable rates. It is recommended students check and see what their rate is and how much it will go up to accommodate any new payments.

CONSUMERS

Have a car loan or any kind of consumer loan with a bank, credit union, or other financial institution or company?  Most payments will go up if linked to the prime rate, unless they are fixed rate payments. Consumers would need to check and see what the extra cost of payments or the borrowing impact would be, and be educated and aware of the cost of borrowing.

IMPACT ON BUSINESS

The higher interest rate will increase the cost of borrowing to invest. This may make Canadian businesses wary of borrowing to invest or expand their businesses.  The higher cost of borrowing would increase the cost of production of goods and services that will be passed onto consumers. This could increase the cost of living and inflation. Higher production costs also make Canadian exports less competitive in export destinations and could impact some manufacturers.

One effect of higher borrowing in the business sector is the as capital become expensive, there could be less investment in the stock market, leading to possible stock market bubbles.

NOT ALL BAD NEWS! 

However, given Canada’s good economic performance, strong job number, and the government’s forecast for more growth, Economic experts say the Canadian economy and its consumers can handle the recent interest rate increases. The Bank of Canada predicts that businesses will continue to expand by borrowing and consumers will continue to spend, although a little more cautiously, with only a marginal effect on Canadian’s savings, expenditure and borrowing habits. The most   important effect of the higher interest rate is expected to be on real estate purchases. This is an area being closely watched as house prices in most major cities continue to rise to astounding levels.