It’s time to sweat about debt.
The interest rate increase announced Wednesday by the U.S. Federal Reserve will have a limited effect on Canada, so let’s not over-dramatize. But the era of rock-bottom interest rates that never move might just be over.
You can’t be sure of that, but then nothing’s been certain in the economy since the global financial crisis seven years ago. All we know right now is that the U.S. economy is considered strong enough to sustain a rate increase of one-quarter of a percentage point in the Fed’s benchmark borrowing rate.
The symbolic effect here is much bigger than the financial one: Historically low interest rates are no longer a given. All your calculations about how comfortable borrowing is should be revisited.
Fortunately, there’s time. Canada’s economy is weak enough that the governor of the Bank of Canada spoke hypothetically about using negative interest rates to jolt the economy if it were to falter. In the next six to 12 months, it seems more plausible for rates to move a bit lower than it is for them to rise. A clear and present danger of rates rising here in Canada won’t arrive until oil prices rebound or an improving U.S. economy somehow wakes Canada up.
But that doesn’t mean Canadians are unaffected by the U.S. rate increase. The Bank of Canada controls the short-term lending rates that influence lines of credit, floating rate loans and variable-rate mortgages, but it has less influence over five-year fixed rate mortgages. Those are set by the bond market, which is not going to like higher U.S. rates.
We may see higher rates on both U.S. and Canadian bonds as a result, and this could filter into five-year fixed rate mortgages. A quarter-point rise on a $400,000 mortgage above today’s rates could increase your payments by $50 per month. On a $650,000 mortgage, the extra cost could run about $83 per month.
Increases like these are manageable. And with the Fed talking about raising rates in a measured way, it’s unlikely we’ll see a quick succession of rate hikes like this. Just remember that the underlying message about rates is changing. No longer can you count on renewing a mortgage at the same or lower rates than you had before.
Here are four tips to prepare you for the higher-rate world that is coming at some point in the future:
On Mortgages: Use a mortgage calculator like this one to see how much your payments would be if you had to renew at rates one-quarter of a point or more than they are now, and then figure out how you’ll reallocate the money from your household budget. Variable-rate mortgages are worth a look because they’re influenced only by the Bank of Canada and immune to what the Fed does.
On Other Debt: If you pay it down now, you’ve insulated yourself against a sustained rise in rates in the future.
On Savings: Keep your eyes on five-year guaranteed investment certificates – if five-year mortgage rates rise, GIC rates should keep pace. Sadly, high-rate savings accounts won’t move until the Bank of Canada does.
On Investing: You need bonds in your portfolio as a cushion against shocks such as a stock market correction or a recession, but bonds are vulnerable to rising rates. Limit the down side by holding short-term bonds, which mature in five years or less. Also, be prepared for so-called rate sensitive stocks like utilities and real estate investment trusts (REITs) to weaken.
Above all, adjust your thinking on debt. Even with the rate risk muted here in Canada, we now have proof that interest rates won’t stay at current lows forever.
The Globe and Mail
Published Wednesday, Dec. 16, 2015 4:07PM EST
Last updated Wednesday, Dec. 16, 2015 5:30PM EST