The next chapter in financial inequality will be the divide between those who can afford to prepare their household finances for the coming recession and those who cannot.
Keeping a stockpile of cash protects you against the interrupted incomes and job losses that are inevitable in recession as employers react to a weakening business environment. Quite a few households can tick this box instantly. They’re the ones who continue to hold cash that piled up during pandemic lockdowns.
And then there are the households who just made it through lockdowns in a financial sense and never built cash reserves – or those who have since spent that money. Telling them to start saving now for the recession ahead seems rather pointless, given the financial pressure they’re already under to afford things such as groceries and gas for their vehicles.
This is why the recession we’re heading into could be the most unfair ever. Never has there been such a clear dividing line between those who can arm themselves with savings for a recession and those who can’t afford to.
Recession talk has picked up lately because no relief is in sight on inflation or rising interest rates. Royal Bank of Canada sees a moderate recession starting as early as the first quarter of 2023. The International Monetary Fund forecasts slower growth for Canada next year, but a worse outlook is possible if inflation stays high and rates keep rising. That’s exactly where we’re at right now.
Let’s say the gold standard for an emergency fund is enough cash to cover six months of household expenses or more. Three months get you a silver saver’s medal, and less than that gets you a still respectable bronze. A general rule is that something in the way of savings is always better than nothing – even a few hundred bucks is valuable in covering off a surprise car repair or household maintenance issue.
High interest rates mean we can dispense with the never very sound idea that a home equity line of credit is all you need for emergencies. Expect to pay around 6 per cent to use a HELOC these days. If you needed $25,000 to tide you over, the minimum monthly interest-only payment would be $125.
Expect the rate on HELOCs and other floating rate debt to rise by at least 0.5 of a percentage point on Oct. 26, with a similar increase possible on Dec. 7. Those are the next dates when the Bank of Canada announces any changes to its trendsetting overnight rate. In early 2023, there are rate announcements set for Jan. 25 and March 8.
Rising rates highlight the way the pandemic has worsened financial inequality. If you have money sitting in savings accounts or guaranteed investment certificates, you’re earning virtually risk-free returns at levels not seen in decades. If you’re mainly a debtor as opposed to a saver, you get squeezed ever tighter as rates rise.
Ratehub.ca figures that someone who bought a $500,000 house five years ago with a five-year fixed rate of 2.69 per cent would see monthly payments rise by $445 on renewal at current rates, to $2,567 from $2,122. Interest costs on variable-rate mortgages rise with every increase in the Bank of Canada’s overnight rate, which has cumulatively increased to 3.25 per cent currently from 0.25 per cent at the start of the year.
Rates are rising to curb inflation, which is another aspect of the economy that highlights inequality. One of the key reasons why inflation is so stubborn is that the financially comfortable people keep spending. As prices go up, they pay up.
Those who don’t have the financial elasticity to afford inflation are in trouble. Record numbers of people are using food banks now, with the economy not yet in recession. The number of consumers declaring bankruptcy or making debt repayment proposals to their lenders was up 26.7 per cent in August on a year-over-year basis. Business insolvencies jumped 66.1 per cent, another sign of stress in the economy.
Get help now, prerecession, if your household struggles with affordability and you see a risk of job loss or lost income in a recession. Try a non-profit credit counselling agency if debts are a problem. Take advantage of today’s strong job market to reposition yourself in a sector or company that can ride through a recession. A safety net of savings is ideal, but it’s understood that many can’t afford it.
PERSONAL FINANCE COLUMNIST
The Globe and Mail, October 17, 2022