Budgeting for interest rate hikes in Canada
Rising interest rates are a concern for many Canadians. Although the current low-interest environment has allowed many Canadians to take on debt and build up assets, you must be aware of the potential downsides. Rising interest rates could jeopardize your finances if you’re a homeowner with a mortgage or an investment property with a HELOC. If you have debts with variable interest rates (such as lines of credit), higher borrowing costs could lead to higher payments and less cash flow. Even those who don’t carry any debt should keep an eye on the trend when planning their budgets – because even if you can pay off your loans early or refinance them at lower rates later down the road, being prepared will help keep more money in your pocket over time.
Rising interest rates can have dramatic effects on household budgets.
A good percentage of Canadians have mortgages. As you might expect, rising interest rates affect mortgage payments. This can mean monthly costs for homeowners, who may also face higher property taxes and utilities. Rising interest rates also affect other types of debt, such as car loans and lines of credit (LOC), which are often used to finance big-ticket items like cars or renovations on a home.
How do rising interest rates further impact the family budget? But, first, let’s look at how they can affect household cash flow and wealth:
- Cash flow: When interest rates rise, it becomes more expensive to borrow money for all sorts of purposes—mostly because lenders will charge more for the privilege of lending out their funds at higher rates than before; this means that borrowers must pay back more over time to compensate them for taking on additional risk.* Wealth: If you’re saving money in an investment portfolio instead of paying down debt—known as “financial repression”—you’ll see greater returns when borrowing costs rise.*
Household cash flow is not keeping pace with debt.
If you’re a homeowner, one of the best ways to prepare for interest rate hikes is to ensure your household cash flow keeps pace with debt. Over the past few years, low-interest rates have encouraged Canadians to carry more debt than ever. Unfortunately, however, many people aren’t saving enough money to pay off their debts when rates go up in the future. As a result, debt balances are increasing faster than income—which means it’s becoming harder for borrowers to pay back what they owe on their loans without taking on even more debt!
Cash-flow vs. Debt-Flow
A good rule of thumb for managing your finances is that if there’s no money coming into your account each month after paying bills and expenses (such as rent), you shouldn’t be spending any money (or going into further debt). Many Canadians have ignored this simple principle over the past decade because they’ve been able to keep up with their payments through low-cost borrowing options like payday loans or high-interest credit cards instead of saving up enough cash flow beforehand through budgeting efforts such as cutting down expenses or increasing income streams through side hustles such as starting an online business at home (eBay selling/Amazon FBA).
Higher interest rates may force house sales.
Suppose you’re one of the many Canadians who have taken advantage of low-interest rates to buy a house. In that case, it’s essential to understand how higher rates might impact your financial situation.
If rates go up, your monthly payments could also increase. To make sure you can afford these costs, it’s essential to set aside enough monthly money. If you don’t have enough savings or investments, consider using some of your home equity as a backstop against rising mortgage payments.
If increases in your income or assets can’t offset higher borrowing costs, they may force some homeowners into selling their homes and renting instead—and we could see a spike in Canadian real estate prices!
Rising rates and wealth effect.
When it comes to interest rate hikes, a few key factors impact the “wealth effect”—the change in consumer spending as a result of changes in the value of their assets. First, the wealth effect is strongest for people who have a lot of their wealth tied up in their homes: if interest rates go down, they can refinance at a lower rate and spend less on mortgage payments; if rates go up, they may be able to take equity out of their home and use it for other purposes.
The wealth effect will also be affected by what type of investments Canadians choose to make with any extra cash after paying down debts (or taking out more debt). If you invest your money conservatively (e.g., deposits), then rising interest rates will not affect how much you spend overall because the amount you get from deposits won’t change much over time either. On the other hand, if you invest aggressively (e
What should we do?
Here are some tips to help you plan for interest rate hikes:
- Understand your financial situation. Take a good look at your current debt, and make sure that the most important things (like rent and food) are covered before making any rash decisions. Then, look at your income and expenses to accurately budget for a potential rise in interest rates.
- Ask yourself whether or not you’re ready for higher interest rates. If not, start making changes now! It’s never too early to start planning for the future.
The best way to prepare is by budgeting for higher costs and investing in financial literacy. This way, you will be prepared when it comes time to make decisions about your household finances.
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