Rising interest rates will harm you only if you choose to gamble with your future and live beyond your means. To be sure, rising interest rates could be a blessing in disguise to help you get on top and stay on top of household finances. The result? More prudence with lifestyle decisions!
It is essential we learn to focus on our decision processes and the correct variables to manage before we decide. We can’t control money or credit, per se. Neither can we manipulate interest rates. The variable we manage and control is us. Therefore, forget about your credit score! It results from your decisions that lead you into or out of debt. Focus on your choices. In fact, rising interest rates might not be bad for the economy or you.
Interest rates have been low for almost ten years. Relatively, they will remain low for the next few years. I recall paying nearly 25% on a variable rate mortgage in the early 1980s. This high rate, coupled with high inflation, fostered wise stewardship of funds, leading to rapid mortgage repayment. Today, many folks in the housing and finance markets grew up on a diet of exceptionally low-interest rates, which created a debt-dependent lifestyle. These people see record low interest rates as normal.
Bank of Canada’s (BOC) target overnight rate fell from 4% (400 basis points) in January 2008 to a low of 0.25% (25 basis points) on April 21, 2009. It remained at that level until June 1, 2010, when it rose to 0.50% (50 basis points). Today the BOC rate is 1.25% (125 basis points). Commercial banks use this interest rate as a reference for their variable mortgage rates. However, for fixed-rate loans, their base is the five-year government bond rate, currently yielding about 2%.
In the USA, the Federal Reserve’s (Feds) interest rate equivalent to the BOC’s rose from 25 basis points in December 2008, to 150 basis points in December 2017. The Feds are ahead of Canada in hiking rates. This pattern is likely to continue as the USA’s tax reform will encourage businesses to grow, employ more people, and increase wages, salaries, and benefits. Meanwhile, in Canada, Prime Minister Trudeau and some of his tax and spend premiers, notably Wynne in Ontario and Notley in Alberta, do not understand that governments don’t encourage businesses to invest by penalizing them with increasing costs, unneeded regulations, and excessive bureaucracy.
Have you been on a debt diet of low interest rates? How do you transition to the new reality of rising interest rates? A few people have asked me these two questions:
- We have a line of credit, mortgage, and credit card debt. Should we roll all loans into our mortgage to fix our debt at the current low rate?
- Do we go for a fixed or variable mortgage?
There are no generic solutions for these questions. Each situation needs separate attention. Let’s exam them sequentially.
Rising Interest Rates And Debt Consolidation
To start, it is essential you understand differences between a mortgage and a line of credit. A mortgage is a loan secured by the value of your home, while a line of credit is credit extended with or without security. With a mortgage, the amount of the loan is fixed, while a line of credit is for a maximum amount which you may or may not draw down.
Restrict your mortgage to the cost of buying and substantial upgrades and renovations to your home. Banks offer home equity lines of credit (HELOC) you can access up to a maximum fixed dollar amount for significant home repairs. Consider your HELOC a mortgage with some advantages and disadvantages over a regular mortgage. Ensure you understand these nuances.
In a low, declining interest rate environment, a HELOC could be attractive because of its variable rate. However, today with rising interest rates your costs could increase quickly. Other lines of credit tend to cover emergencies or other unplanned buys.
Before answering any finance questions, however, it is vital you look at your goals and plans over the next two to three years to see how they might affect spending. Consolidating debt in itself is a bad idea unless you are prepared to make future lifestyle decisions that will not involve extra credit. Debt consolidation does nothing to identify and fix the cause of debt. So, ensure you know how, not why, you fell into debt and have an approach to prevent a recurrence before you contemplate consolidation.
In a rising interest rates environment putting your mortgage into a HELOC could be problematic especially if the economy turns down, you haven’t drawn the full amount, and you haven’t finished your home renovations. This is a risky option.
Fixed or Variable Mortgage in Rising Interest Rates Context
The first decision here is this: Do you fix your cost for a specific future period or do you gamble with your future and hope interest rates reduce? The answer is simple: Fix your costs. Interest rates will rise. They have been at historic lows. Besides, particularly in the USA, the economy should grow, fuelled by the tax reform package that is being implemented. This economic expansion could cause labour shortages and general inflation. So, the Feds will use interest rates to cool the economy.
Whether fixed or variable rate mortgage, evaluate likely effects and ensure your housing expenses fit your budget without the need for extra funding.
Most of all, as you consider your situation, work to start and continue a fund to cover emergencies and avoid lifestyle choices that need debt.
In Canada, the tax and spend Federal government, and at least three Provincial governments are working hard to drive businesses away. Rising interest rates will help to make decisions to relocate outside Canada much easier.
The period of exceptionally low interest rates is over. As interest rates climb, governments would do well to understand they can’t bully businesses to stay in unfriendly business environments like Ontario and Alberta.
© 2017 Michel A Bell