Interest rates and debt: What happens when interest rates rise (Canada)


Maxine McCreadie

April 26, 2022 11:05 am GMT
The Bank of Canada recently raised interest rates by half a percentage point, increasing the overnight rate from .5% to 1%.

This is a steep rise, and follows a pattern of rising rates which will make loans and mortgages more expensive for many Canadians.

In this blog, we’ll explore rising interest rates in more detail, including what interest rates are, why the Bank of Canada has raised interest rates, and the links between higher interest rates and debt.

What are interest rates?

Interest rates act like a financial guide, telling you how much it will cost you to borrow money from a lender, or how much you will be rewarded for saving money yourself.

As a borrower, the interest rate is a kind of borrowing tax, and indicates the amount you will be charged for the privilege of borrowing from financial institutions like banks. Borrowing costs are usually represented as a percentage added annually to the loan amount.

The Bank of Canada regulates and monitors the Canadian financial system, and its role includes setting the overnight interest rate – or policy interest rate – which dictates how much the major Canadian banks charge each other for overnight loans.

This in turn has an impact on how expensive it will be for regular Canadians to borrow money.

Why has the Bank of Canada raised interest rates?

The key interest rate in Canada is the overnight lending rate, a benchmark interest rate that the Bank of Canada adjusts on 8 fixed dates per year. The most recent was this month, where the Bank of Canada’s recommendation was to raise the rate by 50 basis points, from 0.5 to 1%. 

For context, this is one of the largest interest rate hikes in decades – the last time the benchmark rate was raised by so much was back in the year 2000 – and the reason the Bank of Canada gives for taking this decision is to combat inflation.

Inflation in Canada reached a 30-year high of 5.7% in February of this year, which is double the normal range of 1-3%. The bank hopes that by raising interest rates, runaway inflation can be contained and consumer purchasing power will be protected. 

How do higher interest rates relate to debt?

Higher interest rates will place stress on the personal finances of millions of Canadians. Put simply, it’s about to become much more expensive to borrow money, which will have an impact on common lines of credit like personal loan and mortgage rates.

Taken from the Financial Post, the example below demonstrates what a 50-point hike would do to a mortgage – in this case, the buyer has put 10% down on a $700,000 home with a variable rate loan:

Pre-hike: Five-year variable rate of 0.85% over 25 years = $2,404 monthly payment

Post-hike: Five-year variable rate of 1.35% over 25 years = $2,551 monthly payment

That means the interest hike has resulted in an increase of nearly $150 per month in mortgage payments. While some Canadians will be able to absorb that hit, families who are already struggling may be pushed into debt. 

For those Canadians who find themselves in debt already, the situation could be even more dangerous. Now that the price of borrowing has increased so dramatically, the Toronto Star has found that almost 60% of Canadians are worried they won’t be able to afford to repay what they owe

How can I protect myself against higher interest rates?

The Bank of Canada interest rate hike will hit most of us in one way or another, but there are ways you can protect your finances from the worst of the damage. 

Avoid variable rate loans

As the name suggests, a variable rate mortgage is one that fluctuates with the wider market. In situations like the Bank of Canada raising interest rates, your monthly mortgage payment is likely to increase. 

Given we are going through a period of financial volatility, it might be wise to avoid variable rate loans in the medium term.

If you already have a variable rate mortgage, you should adjust your monthly budget to make room for higher mortgage payments and – depending on the length of your agreement – consider whether it might be possible to switch to a fixed-rate arrangement. 

Take advantage of a fixed rate mortgage

The opposite of variable rate loans, fixed rate loans mean your interest rate will remain the same for the entirety of your mortgage term, regardless of the wider financial landscape. That means your mortgage costs will stay the same in the immediate term.

If you are considering taking out a loan or purchasing your own property and have a fixed income, you may be safer with a fixed rate mortgage right now.

That said, your fixed rate isn’t entirely immune from interest rate hikes – when it comes time to renew your mortgage, you will be looking at facing higher costs if interest rates remain as they are or increase further. 

What do I do if I can’t afford rising interest rates?

Unfortunately, many Canadians will simply be unable to afford an interest rate hike on top of bills they’re already struggling with. This can lead people to turn to credit as a holdover, which can precipitate a vicious cycle of debt, high interest, and late payment fees, followed by more debt. 

If rising rates have you worried about your financial situation, there are options available to help you deal with unaffordable debts.

Consumer proposal

A consumer proposal is a formal agreement between you and your creditors to pay back part of the debt you owe via a single monthly payment, based on what you can realistically afford. At the end of the arrangement, any remaining debt will be written off by your creditors. 

Consumer proposals are an alternative to filing for bankruptcy and could result in as much as a 70% reduction of your debt without impacting assets like your home or car. Consumer proposals can help you deal with most types of unsecured debt, including your student loan in certain cases. 

Debt consolidation

A debt consolidation loan is similar to a consumer proposal in the sense that it allows you to roll multiple debts, usually with high interest rates, into a single payment. 

Unlike consumer proposals, however, the process doesn’t involve a debt write-up-off. If you choose to consolidate your debts, you’ll need to repay what you owe in full, but it can make the repayment process easier to manage, and may save you money on interest and charges. 

Where can I get more information on interest rates and debt?

Unfortunately, the landscape of the Canadian economy means further increases in the interest rate look likely. If you’re already struggling to make ends meet as it is, then you can’t afford to wait any longer to deal with your debts.

At A. Fisher & Associates (Debt Relief Canada) we advise hundreds of people each week on how to restructure their finances to deal with debt and the rising cost of living. We’d be delighted to help you too.

Whether you just want to have a conversation about your financial circumstances, or you’re wrestling with debt and considering a formal repayment plan, we have a solution for you. For instant peace of mind, get in touch with our team today.

Maxine McCreadie

Maxine is an accomplished financial writer, known for her expertise in the field of personal insolvency. Having worked in the international insolvency community for a number of years, she has gained a deep understanding of the intricacies of personal finance and the complexities of insolvency processes.

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