Last Updated: October 16, 2022
Interest rate hikes can send consumers into a tailspin, but luckily they don’t directly impact all forms of debt. Knowing how interest rate hikes can affect your monthly bill payments and day-to-day spending can help you manage your money and debt.
Remember when the Bank of Canada sliced its benchmark interest rate twice, all the way down to 0.25 percent in March of 2020? Although interest rates are destined to change, they can catch us by surprise, especially when they increase.
Here at Credit Canada, we help people figure out how to respond to financial hardship, including heightened interest rates and overwhelming debt. Our certified credit counsellors are trained and eager to support and guide you toward a more stable financial future.
So, what does the interest rate hike mean for your day-to-day finances? From credit card debt and car loans to lines of credit and savings — we’ll cover the impact of interest rate hikes in this article.
First thing’s first:
How Much Has Interest Gone Up?
On September 7th, 2022, the Bank of Canada increased the target for its overnight rate to 3.25%. That's an increase of 2.25%, a much larger jump than the 0.5% increase in April, 2022.
Reminder: The prime rate isn’t a promised rate. It’s a starting point for what banks offer a client with a favourable application — such as someone with a low debt-to-income ratio and relatively high credit score.
What Does Increased Interest Rates Mean for Canadian Debt?
The brunt of an interest rate hike will appear on loans with variable interest rates — like lines of credit and some mortgages. However, some fixed-rate loans can also be impacted when it’s time for loan term renewals.
Here are some specific debts and how higher interest rates can affect them:
Credit Cards and Car Loans
Most credit cards have fixed interest rates of 19.99% — an already hefty load on most budgets. But luckily, interest rate hikes typically don’t affect credit card interest rates. That is unless you slack on your payments. If you don’t make your minimum monthly payments, credit card companies can increase their interest rates by 5% or more.
The good news is if you continue to make all your credit card payments on time, you likely won’t feel a hit related to a country-wide interest rate hike. Historically, credit card companies haven’t increased their rates during periods of interest hikes, though other forms of credit have, such as lines of credit and variable mortgages.
As for car loans — same story. Because they have fixed interest rates, they’re typically not impacted by an interest rate hike.
Lines of Credit
You can expect to pay more interest on lines of credit (secured and unsecured) second only to mortgages, perhaps. Why?
Lines of credit typically have variable interest rates, including:
- Personal lines of credit: The average joe might have a personal line of credit for many different reasons, like debt consolidation, covering education costs and course fees, dental and vet bills, etc.
- Business lines of credit: Business owners obtain lines of credit for equipment and other business expenses.
- HELOCs: Home equity lines of credit are offered to some mortgage owners, with the loan amount increasing as you make payments on your mortgage. If you’re thinking of using one to cover renovations for your home, you might consider holding off till interest rates cool off.
Debt Consolidation Loans
Debt consolidation loans can have a fixed rate or a variable interest rate that is based on the prime interest rate. If you have a debt consolidation loan with a variable interest rate, your minimum payment will increase when the prime rate increases, whereas with a fixed rate it won't. However, anyone looking for a debt consolidation loan with a fixed rate will likely pay more in interest when the prime rate increases.
Interest rate hikes have the biggest impact on mortgages with variable interest rates. An increase of just 1% could cost more than $100 extra every month to homeowners in interest. Interest rate hikes also impact:
- Fixed mortgage rates upon renewal
- Mortgage qualification and stress test
- Required down payment
- Home prices
Here’s the good news. If you have a fixed mortgage rate, you’re locked in at your existing rate for however much longer there is in your term. So, you might not have to pay more each month…yet. However, if renewal is coming up, you’ll have a much harder time securing the same mortgage rate when the prime interest rate increases.
And if you have a variable rate mortgage? You can see an increase in interest amounts as soon as your next payment date when interest rates fluctuate.
Remember one thing — a variable rate increase won’t necessarily change your monthly mortgage payment amount. (Some banks guarantee that for the duration of the loan term, even with variable rates.) However, an interest rate hike will increase the amount of money you pay towards interest versus the principal. So, while the bank might not ask for higher mortgage payments, they will take away some of the money going towards your principal and reallocate it to the interest on the loan. Meaning it will take you longer to pay back the loan and you'll pay more in interest.
But overall, who’s affected the most? Unfortunately, first-time homebuyers.
How Do Interest Rate Hikes Impact First-Time Homebuyers?
Anyone saving up for a home will have to budget for more interest each month than originally anticipated when interest rates increase. And, they’ll need to qualify for an even more robust stress test.
Interest hikes make it harder to qualify for a mortgage. When interest rates go up, applicants need to pass a higher stress test to secure a loan. (This also rings true for people looking to refinance their mortgages — moving their mortgage will have stricter requirements.)
“As interest rates climb, so does the qualifying rate for consumers,” says MortgageOne Solutions broker Darlene Vilas. “The B-20 ruling requires banks to qualify consumers for mortgages at the higher of the benchmark rate (currently 5.25%) or the contract rate plus 2% (whichever is higher).”
Bottom line? “Consumers will qualify for less money to buy homes and will need larger down payments,” says Vilas.
So, homeownership becomes less attainable when interest rates rise.
Do Interest Rates Affect Credit Performance?
High-interest rates don’t directly influence your credit score. Credit bureaus don’t consider interest rates when calculating your score or assessing your credit utilization ratio.
However, some experts predict that interest rate hikes will lead to credit performance deterioration over time. Interest rate fluctuations can have a stronger impact when coupled with other factors, like inflation or when government support programs expire.
More expenses and less income make it more difficult for people to keep up with their regular debt payments. And so that indirect domino effect is what can impact your credit score.
Luckily, the interest rate hike actually poses some simultaneous benefits, even if you’re a lower-income household.
How Do Interest Rate Hikes Help?
Interest rate hikes offer two benefits: increased returns on savings accounts and correcting an inflated market.
1. Higher Interest Means Higher Returns on Savings Accounts
Loans aren’t the only things that come with interest. Remember that TFSA you opened up a few years back? You might have been dismayed at the slow growth and meager 1.5% interest rate — a secure investment but slow return.
An extra 50 percentage points in interest heightens your return on popular savings accounts, like GICs, TFSAs, and RRSPs.
If you can, put more money in your savings accounts if possible. You’ll pump up your interest savings and have less room in your budget for frivolous spending.
2. Interest Rate Hikes Tackle Inflation
Have you ever noticed an uncharacteristically high grocery or gas bill? Funny enough, interest rate hikes are meant to combat inflation.
Now, you might think: how do higher interest rates tackle inflation? Sounds like more money out of our pockets, right? You’re not wrong – but the double-whammy of expenses is meant to be temporary.
While many factors can impact inflation (supply chain interruptions, natural disasters, and global health crises, for example), one culprit behind interest rate hikes could actually be low-interest rates.
For example, after the COVID-19 pandemic, interest rates were uncharacteristically low in 2020. This was meant to encourage businesses to expand and hire workers and pump up the economy, propelled by easier avenues to access credit. But it also encouraged people and businesses to borrow more and more, mainly in mortgage debt.
When people can access low-interest rates, it can be extremely tempting to buy, buy, and buy. That brings prices up. Interest rates are increased to correct and cool down high debt-to-income ratios and discourage excessive borrowing.
3. Housing Prices Decrease with Higher Interest Rates
An inflated housing market causes skyrocketing prices, which makes it harder for many first-time homebuyers to achieve homeownership.
The uptick of people buying houses during periods of low-interest credit, such as during COVID-19, causes a massive real estate boom, making prices climb higher and higher.
With higher stress test thresholds and less incentive to borrow for a mortgage, fewer Canadians will bid up housing prices, thus cooling the market.
How Do You Manage Debt When Interest Rates Rise?
Higher expenses might feel stressful. We know the feeling and completely understand. But you can overcome the burden of higher interest rates.
First, it's important to understand they’re meant to be temporary. History shows ups and downs with interest, and they never remain too high or too low forever.
In the meantime, you might consider:
- Paying debts using the Avalanche Method: This debt repayment method involves paying off the highest-interest debts first.
- Think twice before borrowing: Is an extra line of credit vital right now, or can it wait a year or so? It’s generally best practice to avoid borrowing when interest rates are high.
- Have an emergency fund: Saving for a rainy day might be hard on a smaller budget but there’s always room for adjustment. If you can’t save more than a few bucks here and there every week or month, don’t get discouraged and give up. Save whatever amount you can every month for emergencies (which tend to be more expensive during times of inflation) and increase your contributions when it's feasible.
Deal with Higher Interest Rates with Credit Canada
Of course, all these methods are helpful but may not be enough to tackle your personal debt scenario. That’s where Credit Canada comes in to help you fill in the gaps. Our free credit counselling services are a safe space for you to discuss your financial situation, including your obstacles and biggest goals.
If you’re struggling with higher interest rates and keeping up with debt payments, support is here. Contact Credit Canada today for a free consultation.