For many who have a large amount of debt from loans or credit cards, interest rates can be a major cause for concern. Interest, or the percentage-based fee that financial service providers charge in return for allowing you to borrow money, is a key factor to consider when using a credit card or getting a new loan.
Increasing loan and credit card interest rates are concerning for anyone who is already struggling to control their debt. With higher interest rates, debt accrues faster so it’s harder to pay off debt.
Are Interest Rates Going Up in Canada?
As of December 2022, interest rates in Canada have been on the rise. While not close to the historic highs of the early 1980s, the Bank of Canada raised rates to 4.25%—the seventh rate increase of 2022.
What Is the Canada Prime Rate?
The term “prime rate” refers to the interest rate that banks charge to their most credit-worthy customers. In Canada, the prime rate is based on the average interest rate that the Bank of Canada wants to see in the marketplace for overnight loans between financial institutions.
The prime rate is usually used to form the basis for interest rates for all kinds of financial services. So, the higher the prime rate, the higher interest tends to be for loans and other services. However, this isn’t absolute. Other factors, such as the borrower’s credit rating, available assets, and the like can affect the actual interest rates a financial institution offers to that individual.
Variable loans may change how much interest they charge based on fluctuations in the prime rate, so it’s important to understand trends in the prime rate before agreeing to a variable loan.
How Loan and Credit Card Interest Rates Affect Debt
Rising interest rates can greatly increase the speed at which debt grows.
Interest is a key part of calculating the true cost of a loan or credit card purchase. For example, say that you’re looking for a mortgage to help finance the purchase of your dream home. You get two loan offers that cover the full value of the home, one at an interest rate of 6% and one at a 5.95% rate. A 0.05% difference might not sound like a lot, but it adds up faster than you’d think.
Say that the loan was for $500,000 to be paid over a period of 25 years. Without interest, that would be 300 monthly payments of $1.666.67. Now, let’s say that you accrue 6% interest semi-annually—meaning that, if no payments were made or extra fees were charged, you’d add $30,000 to the debt every six months (or $60k a year).
Meanwhile, if your interest rate was 5.95%, you would accrue $29,750 of interest over six months (or $59.5K a year). That slight difference in the total interest rate could save thousands of dollars over the years.
This is just a very rough estimate that doesn’t account for other costs like property taxes, HOA fees, utilities, extra payments, etc. Additionally, factors like loan type (such as fixed rate vs. variable rate loans), frequency of compounding, and other fees can impact the speed that the debt can grow.
What to Look for when Examining Interest Rates
Whether you’re considering taking on a loan or a credit card, there are a few things that you’ll want to take a look at before signing any agreements:
How Often the Interest Compounds. How frequently does the interest on the debt compound? Is it yearly, semi-annually, monthly, weekly, or daily? The more frequently the interest compounds, the faster the debt will grow. So, even if one credit card or loan claims to have a lower interest rate, if it compounds more frequently than other offers, you might find yourself paying much more in interest than you would with a credit card or loan with a slightly higher rate that compounds less often.
How Extra Payments Are Applied to the Balance. When extra payments are made on a loan, do they go toward the principal balance or are they applied to future owed payments? The assumption would be that they go to the principal, but that isn’t always the case. For example, some student aid loans in the USA won’t apply extra payments towards the principal unless you specifically request it in writing (something to consider if you’re thinking about studying at an American University).
If the Loan is Fixed Rate or Variable Rate. Loans can be either fixed-rate or variable-rate. With a fixed rate, the interest is determined at the time of the agreement and cannot change outside of specific circumstances. Meanwhile, a variable-rate loan’s interest might change depending on the current prime rate. Which is best? It depends on your confidence in whether the prime rate will go up or down over the course of your loan. With fixed-rate mortgages, you don’t have to worry about changes to the wider market, but with variable-rate mortgages, your interest rate could actually go down in the future—but the opposite could also happen and turn a reasonable-rate loan into a high-cost loan.
Any Potential Fees and Penalties. In any loan or credit card agreement, it’s important to check for what the lender’s fees or penalties are for specific situations. For example, if you have a late payment, will that result in a one-time fine for a set amount of money or an increase in your interest rate? What happens if you take a cash advance from your credit card? Be sure to ask the lender or credit card company about any service or penalty fees you might encounter—they should be able to provide a clear answer!
Whether the Debt Is Secured or Unsecured. Some loans or credit cards can be secured—meaning that they’re backed by some form of collateral. In the case of mortgages or auto loans, the collateral is typically the house or vehicle the loan is used for. With secured credit cards, the collateral often takes the form of a down payment used to open the card account. If you have a low credit score, secured debt is often easier to qualify for. It may also have lower interest rates since the risk for the lender is reduced due to the collateral.
Simple Steps to Reduce Debt
Are you struggling with a large amount of debt due to rising credit card and loan interest (or other factors)? Reducing loan and credit card debt can be a struggle. However, there are a few things that you can do to reduce debt even when interest rates are rising.
Consider Renegotiating or Refinancing Your Debt
In some cases, you can work with your creditors to negotiate down your debt or limit your interest rates to make paying the money owed easier. This can do a lot to curb the growth of your debt and help you get back on your feet.
Why would creditors agree to this? One reason is to avoid the risk of borrowers filing for bankruptcy where they might recover even less. Insolvency can be unpredictable for lenders—especially if the borrower owes multiple creditors. By working with you to make your debt more manageable, they can reduce their risk.
Examine Debt Consolidation Loans
If your credit is still pretty solid, you might be able to go to your bank and get them to sign off on a debt consolidation loan—a loan where you use the money granted to pay off your outstanding debt so that you only have to deal with the bank.
Debt consolidation loans can greatly simplify debt repayment and potentially help you reduce your interest rate. However, it can be easy to fall into the trap of putting yet more purchases on your credit cards once you’ve used your consolidation loan to clear them. So, it might help to cut up your cards once you’ve eliminated the balance using your consolidation loan and switch to your debit card or a prepaid card for your shopping needs.
Another potential issue is that this option is heavily reliant on your credit score. If your score is low, then you may struggle to find a lender that offers an affordable interest rate.
Look into Debt Consolidation Programs
If you’re having a hard time negotiating with creditors directly and aren’t able to secure a consolidation loan, it might be time to consult with a credit counsellor and ask about joining a debt consolidation program (DCP).
A DCP is a program where a credit counsellor works with you and your creditors to combine multiple debts into a single, easier-to-manage monthly payment. Your counsellor will reach out to creditors to negotiate easements on debt and/or interest rates to help make your debt more manageable, provide advice on managing your debt, help you create a budget that you can stick to, and put a stop to those annoying collection calls so you can get some peace and quiet.
Are you ready to get rid of your debt while building a more secure financial future? Reach out to Credit Canada to get started!