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Where Will Rising Interest Rates Hurt Most?

Updated: Jan 20, 2023

Rising inflation combined with a strengthening post-pandemic economy gives both reason and opportunity for the Bank of Canada (BOC) to further raise interest through to the end of 2022 and beyond.

The 1% increase to the benchmark overnight rate in early July was a wake-up call that they were not bluffing and are prepared to act aggressively. Depending on how inflation trends, we could be looking at interest rates that are 1% or 2% higher within the next year.

Before jumping into the effects of higher interest rates, we should clarify one common point of misunderstanding about the prime rate and the BOC overnight rate. The prime rate is the basis for most variable-rate loans, including mortgages and lines of credit. It is determined by the major banks and currently sits at 4.7%; 2.2% higher than the BOC overnight rate. Although these two rates are different, the key takeaway is that the prime rate moves in lockstep with any changes to the BOC rate, usually within a few days.

Now that we have that out of the way, just how will future interest rate hikes affect your debts?

Variable rate mortgages The percentage of Canadians holding a variable rate mortgage surged in 2021 and now stands at about 50%. Any rise in the BOC rate is met by an equal rise in variable-rate mortgages, so the impact is very clear and takes effect quickly. A 1% increase will add around $200 to the monthly payment on a $500K mortgage. Keep in mind that the interest rate has already risen by 3% since the beginning of 2022!

Home equity line of credit (HELOC) HELOCs usually have a variable interest rate that will rise in conjunction with any BOC rate hikes. A $100,000 balance carried on your HELOC will cost you about $20 more in interest each month for every 0.25% increase by the BOC.

Credit card debt The interest rate on your credit card and how it can be adjusted are outlined in your cardholder agreement. There is usually little correlation between credit card rates and the rates set by the central bank. However, credit card rates are already so astronomically high that it is unlikely you would even notice a 1% increase! Our advice is to attack any outstanding credit card balance ASAP.

Personal lines of credit There are fixed and variable rate options out there. If you selected the lower variable rate when you signed your agreement, expect to pay more going forward on any outstanding balance.

Car loans Most car loans in Canada are fixed, but the average fixed rate is rising quickly and now sits at about 5.25%. While not common, variable-rate car loans are loans available and your payment could be affected by interest rate hikes.

Student loans There are provincial and federal student loan programs with different interest options so the effect of rate hikes will vary. The default choice for Government of Canada student loans is variable interest “at prime” with a fixed rate option at “prime + 2%”. The point is mute right now as interest charges are currently suspended, but variable-rate student loan holders will see a significantly higher payment when interest charges resume in April of 2023.

Most of us will be paying more interest as we move through 2022 and into 2023. A mortgage or some other debt may be inevitable and not all debt is bad, but it’s important to understand your interest expense and adjust your repayment priorities accordingly.

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