Rising interest rates will harm you only if you 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 items 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. So, forget 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 be good for the economy or you.
Interest rates have been low for around ten years. And they will stay low for the next few years. I recall paying 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 low interest rates, which created a debt-dependent lifestyle. These people see record low interest rates as normal.
Rising Interest Rates Could be a Blessing
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 stayed 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 rate as a reference for their variable mortgage rates. But, for fixed-rate loans, their base is the five-year government bond rate, now 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 rate hikes. This trend should last as the USA’s tax reform will spur firms to grow, hire more people, raise wages, salaries, and benefits. But, in Canada, Prime Minister Trudeau and Premiers Wynne in Ontario and Notley in Alberta, will continue to tax and spend and tax and spend. They do not realize that taxes discourage firms from investing. Why should a company invest when high taxes penalize them? Besides, unneeded regulations and excessive bureaucracy comes with a high tax regime.
Are you on a debt diet of low interest rates? How do you transition to the new reality of rising interest rates? A few people asked:
- We carry a line of credit, mortgage, and credit card debt. Should we roll loans into our mortgage to fix our debt at the current low rate?
- Do we go for a fixed or variable mortgage?
The answer? It depends. One size does not fit; each person and family needs separate attention.
Rising Interest Rates And Debt Consolidation
To start, 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. The bank fixes the mortgage value and sets the largest value for the line which you may or may not use.
Restrict your mortgage to the cost of buying, big upgrades, and renovations to your home. Banks offer home equity lines of credit (HELOC) with an upper limit for large home repairs. Consider the HELOC a mortgage with pros and cons versus a regular mortgage. Make sure you understand the nuances.
With low and falling interest rates, you might afford a HELOC as the rate varies. But, today with rising rates, costs will escalate and burden your budget. Regular lines of credit cover emergencies or unplanned buys.
Before you answer finance questions, review your goals and plans over the next two to three years. Today’s decisions might prevent you from doing those goals. If you plan to merge loans, know you will stay in debt unless future lifestyle decisions do not involve extra credit. And realize debt consolidation does nothing to spot and fix the cause of debt. So, make sure you know how, not why, you fell into debt and have a plan to prevent a recurrence before you merge your debts.
When interest rates rise, don’t put your mortgage into a HELOC. That will be a problem when the economy shrinks and the bank caps your line of credit. Then, if you haven’t drawn the full value, you won’t finish your home renovations or other project. This is a risky choice.
Fixed or Variable Mortgage in Rising Interest Rates Context
Here is the first decision: Do you fix a cost for the future or do you gamble with your future and hope interest rates reduce? The answer is simple: Fix your costs because interest rates will rise. They have been at historic lows. Besides, in the USA, the tax reform package will grow the economy. This economic expansion could cause labor shortages and general inflation. So, the Feds will use interest rates to cool the economy.
Whether fixed or variable rate mortgage, test effects and make sure your housing expenses fit your budget with no extra funding. Still, start and continue a fund to cover emergencies, and avoid lifestyle choices that need debt.
In Canada, the tax and spend federal government and three provincial governments are working hard to drive businesses away. Rising interest rates will help to move them outside Canada.
Record low interest rates are done. As interest rates climb, governments would do well to understand they can’t bully firms to stay in hostile business climates like Ontario and Alberta.
© 2017 Michel A Bell
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