It's time to start planning your rising interest rate escape plan.
Rates aren't on the increase just yet. But the Bank of Canada on Tuesday indicated -- central banks always indicate, they never say -- that economic conditions are improving enough for it to start looking for an opening to raise rates from today's freakishly low levels. One year from now, it's quite possible rates will be higher than they are now and climbing.
As recently as September 2008, the central bank's benchmark overnight rate was at 3 per cent. It fell as low as 0.25 per cent during the financial crisis and its aftermath, and was then ratcheted back up to 1.0 per cent in summer 2010. There's your template for future rate increases. Nothing dramatic, just slow and steady increases that will make a wide variety of borrowing more expensive.
Lines of credit, hugely popular in recent years, are an obvious place to start in preparing for higher rates. Every time the overnight rate increases, the major banks will make a corresponding increase in the prime rate that guides credit line borrowing costs. Floating rate loans are another type of debt to attack now, before interest costs rise.
If you're looking at buying a home, fixed-rate mortgages make a lot more sense now than variable-rate mortgages. Remember, the interest costs on a variable-rate mortgage will rise every time the prime rate goes higher. Also, rates today on fixed-rate mortgages are still attractively low.
Speaking of the housing market, low interest rates have fuelled the long rally in prices in many cities across the country. Rising rates could easily cool the market off, so think twice about buying a home that's at the limit of your affordability range.
Don't be complacent about your ability to afford higher rates. Not a lot of families have enough slack in their cash flow to easily absorb higher interest costs on loans or mortgages. If you're paying more to borrow, the money has to come from somewhere.
There's certainly justification for skepticism about rising interest rates. Since rates plunged in the crisis, there have been repeated warnings about increases that never came to pass because of global economic issues like Europe's debt mess and weakness in the U.S. economy. But here in Canada, the central bank has just increased its 2012 growth forecast, and it described the U.S. recovery as being more resilient.
It's not just an improving economic outlook that puts pressure on the Bank of Canada to raise rates. Excessive household debt levels are a big concern for the central bank, and higher borrowing costs are one way to halt the trend. Plan now for the rate hikes ahead.