The Bank of Canada has begun the process of slapping Canadians back to reality on interest rates.
Economic growth is picking up and the central bank made it clear earlier this week that it's looking at whether to raise rates. CIBC Economics sees the bank raising rates by a total 0.5 of a percentage point in the first six months of 2018, or a bit sooner.
We've had speculation, off and on, about higher borrowing costs in the past decade or so and rates stayed low. Today, risks to the economic outlook include a correction in the housing market, high household debt levels and weak wage growth. But the U.S. economy has been strong enough lately for rates to start rising, and it looks like Canada could follow the same pattern if our overall economic picture continues to improve.
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In any case, preparing for higher interest rates is like starting to exercise more. You'll end up in better shape. Here are six things you can do to get ready for higher rates on mortgages, lines of credit, car loans and more, and a few additional points for savers and investors.
1. Check when your mortgage renews
Find out whether your renewal date is in the next six months or so and see if it's possible to renew early. Some lenders will let you renew several months before the actual renewal date – the question is whether they offer you a decent rate. If not, talk to other lenders about what they can offer if you transfer to them on renewal.
2. Go with a fixed rate mortgage
Most people are already doing this, but there is a group of home owners who rightly point out that variable rate mortgages have been a long-term money saver. Looking forward, a fixed rate mortgage offers two layers of protection. One, your payments are set for the term of your mortgage. Two, you eliminate the stress of worrying about rising rates. Remember, variable-rate mortgages adjust as interest rates change. If you already have a variable-rate mortgage, think about locking into a fixed-rate loan.
3. Consider a lump-sum mortgage prepayment
Lowering your principal today means less to finance at a higher rate in the future. Even if rates don't rise, you'll save on interest costs over the long term.
4. Lock in a mortgage rate if you're buying a home
Lenders will hold rates for as long as 90 or 120 days. It's a no-brainer to get a commitment on today's rates, even if you're only half serious about buying.
5. Start chipping away at your line of credit balance
The federal Financial Consumer Agency of Canada says 25 per cent of people with lines of credit are making the minimum payment every month, often just interest. Forty per cent do not make regular payments to lower their loan balance. In a higher rate world, those habits for managing a line of credit will keep you indebted indefinitely. Start regularly paying principal down now, while your interest costs are still low.
6. Cool it on the car buying
Low rates have fed a multi-year surge in car sales and allowed people to get into more expensive vehicles. Even with low rates, data from J.D. Power shows the average monthly loan payment was above $600 in April, and a stunning 52 per cent of new vehicle loans had terms of seven years and longer. There's a recklessness shown in these numbers. Car loans should be five years, max. Buy cheaper vehicles to make that happen.
And, three points for investors and savers:
-Watch for better rates on savings
If and when the Bank of Canada starts raising rates, make sure the bank or credit union where you have your high rate savings account reacts by bumping up your return. If not, find a more competitive bank.
-Be cautious with long term bonds and bond funds
Returns from long-term bonds have been fabulous in recent years because of the declining interest rate trend. But rising rates would hit long-term bonds the hardest. Stay with bonds maturing in five years or less, or use a short-term bond fund.
-Brace yourself for some dividend stocks to struggle
Utility, pipeline and telecom stocks may wilt somewhat as rates rise, and real estate investment trusts might do so as well. If your goal is to generate dividend income, ignore the price decline.
Rob Carrick