Two Surprise Interest Rate Hikes! Now What?

In the past 2 months, the Bank of Canada has raised its overnight lending rate from 0.5% to 1.0%. That means all variable rate mortgages, line of credits, and other loans that rely on this prime rate is now more expensive.

How much more expensive?

Well that depends on how much you've borrowed. If you're were wise (and lucky enough) to purchase a house in the $500,000 range with a mortgage of $400,000 (assuming a 20% down payment to avoid CMHC insurance), then this 0.5% increase will cost you an additional $2,000 a year or $166.67 a month.

Hmmm... only $166.67 a month? Why all the doom and gloom?

Well, there was this article here. Approximately, 47% of Canadians are living paycheque to paycheque. That means an increase of $166.67 can push them into credit to cover the shortfall. Even if it's tiny at first, it can potentially snowball.

It's easy to dismiss this. This wouldn't happen. People would just cut back on something to cover the $170 a month.

However, before the financial crisis, interest rates were between 3.0% and 4.5%.

Assuming, the Bank of Canada gradually increases the rates to 4.0% from the current 1.0%, that $400,000 mortgage will now cost an extra $12,000 a year in interest payments.

That's a hefty increase. However, this isn't taking into account people will huge mortgages! This, in part, of the increased housing prices in the Toronto and Vancouver area. On a house with a $750,000 mortgage, that's an increase of $22,500 of increased interest payments a year. Yikes!

Would you be able to scrap up an extra $1,875 a month if you're living paycheque to paycheque? Unlikely.

So what do we do?

Well, the good news is it will likely be a while before rates go back to 4.5%. Generally, the Bank of Canada only increases the rate 0.25% at a time. If they were to increase the rate every 6 weeks by 0.25%, it would be 84 weeks before they reach 4.5%. A very unlikely scenario considering the Canadian economy, while much stronger, is still relatively fragile.

In the meantime, just continue to live within your means. The increase in rates shouldn't break your bank. Just continue to max out your registered accounts yearly (RRSP, TFSA, RESP, RDSP, etc.) and maybe put the excess into your mortgage rather than your unregistered accounts if you cannot stomach the increase in your mortgage payments*.

If you're not maxing out your registered accounts, as long as you're still putting away something after the increase of expenses are factored in, you are still in great shape. The worst case scenario, with interest rates going up, you can sell your investments to help pay off your mortgage faster. I know, stocks generally increase over time at a rate that's higher than the interest rate of a mortgage. However, if you really can't stomach the risk, this is an option.

*However, if you can't stomach the increase perhaps you shouldn't be on a variable rate mortgage.


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