Rising interest rates and you: What does it all mean?
If you have been reading the news lately, you may know that the Bank of Canada increased the prime rate again earlier in January. You may also know that this is the third time it increased the prime rate over the past year. What does an increase in the prime rate have to do with you, as a consumer? Great question! It will be helpful for us to understand how this change can affect our everyday lives.
According to general macroeconomic theory, there are a variety of effects that result from rising interest rates. In this post, we will talk about two of the effects that will be most relevant to the regular consumer: a stronger dollar, and more expensive debt.
Rising interest rates lead to a stronger dollar
When Canada raises the interest rates, it encourages more money to flow into our country. People from economies with lower stability, look for less risky investments. That leads, theoretically, to more demand for Canadian dollars, raising the value of our money in comparison to other currencies.
For those who like to do a lot of shopping in the United States, this could mean that you’re getting slightly better deals in the near future. However, we should keep in mind that the US is also looking to increase their interest rates. That means the relative value of our currencies will stay similar. Thus, to take advantage of a stronger dollar, you may have to fly out somewhere much further away!
Holding debt becomes more expensive
For most people, the effect of rising interest rates on debt will probably be the very profound. Just think about which forms of debt you have on a daily basis. You may have a mortgage, a car loan, a business loan, credit cards, or personal lines of credit. A rising interest rate may affect each one of those.
One key factor is whether your rates are locked-in or variable. We suggest that you look at your various loans and lines of credit to determine which kind you have. If your rate is locked-in, that means the interest rate on your loan won’t change, until time of renewal. If your rate is variable–some institutions may refer to it as “floating”–then you’ll have to budget accordingly, as your monthly payments will be increasing a little. Let’s take a look at an example:
If you had a $100,000 line of credit at a variable rate of prime + 1%, before the rate hike you would have had an interest rate of 3.2% + 1% = 4.2%. With the higher prime rate, you will now have an interest rate of 3.45% + 1% = 4.45%. So, instead of paying $350 a month, you will now need to pay $375 a month in interest.
As always, it’s important to know that there is a difference between good debt and bad debt. In a rising interest rate environment, we should be even more diligent in making sure that the debt we decide to take on falls firmly under the “good debt” category.