Posted on Friday October 14, 2022

How to respond to rising interest rates?

Since the last hike in September, the key interest rate is now 3.75%. This remarkable increase reflects the Bank of Canada’s desire to rein in skyrocketing inflation, which is at a record high of well over 7%. What does it all mean for consumers?

We asked Yves Parisé, Regional Vice-President, Acadian Peninsula, and Stéphane Breau, Director of Finance and Risk Management Specialist, to weigh in on the situation and rising interest rates.

Pandemic, inflation, war in Ukraine: Multiple factors to blame for rising interest rates

Scarcity of materials

Multiple factors are behind the key interest rate hikes. First, the ongoing pandemic has had an undeniable effect on inflation. “Slowdowns in the production chain have caused supply problems,” explains Breau. “Right now, there’s a global shortage of microchips and stockouts in a number of areas. Case in point: Car dealership lots are still empty, and scarcity inevitably leads to higher prices.”

More savings in consumers’ pockets

The pandemic has also caused people to put their lives on hold. Spending less on gas because you’re teleworking? Have a hefty vacation fund sitting idle in your savings account? Stopped going to restaurants or movies? This “situational” saving is caused by the same outside circumstances that have stopped people from spending in recent years. The result is a $140 billion surplus in Canadian taxpayers’ pockets.

The unexpected savings have prompted many to purchase big-ticket items such as recreational and off-road vehicles—and with higher demand comes higher prices. But how do you dampen consumer enthusiasm? By increasing the key interest rate.

An inflationary global economy

The war in Ukraine is also having an impact because it directly affects the price of oil and thus the price of any materials or commodities that need to be transported. This has increased prices on gasoline, food and all consumer goods, which contributes to inflation.

“When you have people sitting on their savings, an economy at full employment and an international conflict, there’s a lot of upward pressure on prices,” says Breau. “The Bank of Canada is betting on key interest rate hikes to keep the market in check. The goal is to tweak the rate just enough to stifle inflation without triggering a recession.”

Effect on consumers

What impact does this rate increase have on consumers? Isn’t there a risk that this could put some people in financial jeopardy?

Our two specialists see reason for optimism. Rising interest rates will not have as big an impact on the less affluent, who are hit harder by inflation because they have less financial wiggle room.

“The long-term impact should not be too substantial for individuals,” says Yves Parisé. “The biggest debts most individuals carry are for buying their homes and cars. So they’re going to have to make choices that fit their budget, which could mean opting for a cheaper home or cutting back on discretionary spending.”

Impact on mortgage loans

Worried you won’t be able to make payments if the 3% mortgage rate you were originally approved for goes up to 5%? Good news: When you got approved for your loan, you actually qualified for an interest rate 2% higher than the then-current rate. So in theory you should be able to absorb this increase without losing your shirt.

“It’s called a stress test,” says Parisé. “It’s a measure that ensures the individual who took out the loan will still be able to pay if rates go up. Obviously, it’s possible their situation may have changed (new job, for example). If so, we can sit down with them and go over their options.”

Solutions tailored to your situation

Inflation affects real estate too, and we’ve seen a big increase in property values. While the market craze is slowly winding down across Canada, the slowdown has been more gradual in New Brunswick, though it looks like the trend toward overbidding and unconditional offers is on the wane. If your home has gone up in value, you’ll have some attractive options when it comes time to renew your mortgage.

Big projects on the back burner?

“Now’s the time to finally do those renovations you’ve been dreaming about!” says Parisé. “Your house is suddenly worth a lot more, so you’ll have the flexibility you need to put the cost of renovations on your mortgage. You can finally get to those home projects that were once out of reach.”

Loan adjustment

Are rising interest rates having a major impact on your finances? One option is to consolidate your debt by transferring it to your mortgage. “Mortgage rates have gone up, but the cost of this type of borrowing is still lower than the interest on a credit card balance,” Parisé says. “This strategy isn’t right for everyone, but if you need to get your budget on track, why not take advantage of rising property values get your finances under control?”

Don’t give in to your anxiety

For borrowers, the biggest source of concern is not knowing which way the rates will go. Will they keep going up or have they peaked? While Stéphane Breau can’t predict the future, he advises people to stay the course. “Some are considering paying a penalty to break their mortgage so they can sign on at the current rate for fear that rates will be higher when it’s time to renew. If it helps them sleep better at night, this is an option, but considering how hard it is to predict which way the wind will blow, we advise them to stick with the original plan for now. Keep in mind that some four in five people won’t have to renew their mortgage until next year or after. That means there’s time to prepare.”

Our financial tips to ease the impact of rising interest rates

1. Make a budget

“It’s the first thing you have to do,” says Yves Parisé. “Draw up a list of your expenses, income and consumption habits. In times like these when the cost of living is high, you have to identify what expenses are essential, where you can cut back and what adjustments are needed to make ends meet. Once you’ve got a clear picture of your situation, it’s easier to take action.”

The budget calculator on our website can help you with this.

2. Looking to buy a home? Start saving today!

Once you’ve worked out your budget, make sure you can set enough money aside to build up a down payment of at least 5%. Property values have gone up a lot so you’ll need a bigger down payment too. “It’s highly regulated and there’s no way around it,” explains Parisé. “You can also take advantage of current or future programs such as the HBP and FHSA .”

Think about it: The bigger your down payment, the smaller your mortgage—and the less vulnerable you’ll be to rate fluctuations!

3. Keep incidental expenses in check

If you want to get a 5% mortgage rate, you’ll need to qualify for a 7% rate. “It’s definitely not an option for everyone. For any young couples or single people looking to buy their first home right now, it’s important to keep discretionary spending to a minimum. It’s time for some hard decisions!”

4. Hold onto your investments

It’s easier to set money aside in the current environment. “We’ve seen turbulent markets lose value, but we’re also seeing significant rate increases,” says Breau. “I’d advise anyone who is already investing in the financial markets to keep at it. If you have extra cash, the current rates are very attractive. Last year, the interest rate for term savings was practically zero. Now you can get anywhere from 2% to 3% or even 4% interest.”

5. Make an appointment with your advisor

UNI offers a wide range of in-branch resources. Our advisors are committed to helping our members improve their financial knowledge. Feel free to schedule an appointment to take advantage of these services!

“All our specialists are here to help you make a budget and assess your financial situation to provide you with solutions tailored to your needs. Don’t be afraid to ask questions, even if you decide you want to go it alone,” advises Yves Parisé.