After racking up debt during years of rock-bottom interest rates, Canadians are being urged to rethink their spending as they face the prospect of rising borrowing costs coupled with runaway inflation.
“You have to completely recalibrate your spending, recalibrate the way you live your life,” advises Laurie Campbell, director of client financial well-being at debt relief specialists Bromwich and Smith.
Much like dieting, she says managing money under stress requires lifestyle changes to avoid reverting to old habits.
Mme Campbell suggests people take a close look at their overall financial picture and make a serious effort to reduce debt as much as possible, even though the lifting of pandemic measures will likely spur the desire to get out and spend.
“I can’t blame them, but as they do, we’re going to see the debt-to-income ratio go up. And with interest rates and inflation rising, it’s a bit of a perfect storm,” she said in an interview.
Many observers expect the Bank of Canada to raise its key interest rate by 0.25 percentage points on March 2, and to proceed with several other rate hikes over the next two years. In a speech on Wednesday, central bank governor Tiff Macklem made it clear that higher inflation would translate into higher interest rates.
“Inflation is too high and we will bring it down,” he said.
Interest rates for variable rate mortgages, credit cards and lines of credit closely track the central bank’s policy rate.
Higher interest rates will not immediately affect homeowners with fixed rate mortgages until they are ready to renew their loan. Those looking for peace of mind could lock in their mortgage before rates go up.
Mme Campbell expects insolvencies, which are quite low at the moment, to increase over the next year as more people risk being unable to make minimum payments as the price rises. groceries and gasoline.
“For some people, it’s going to be a bit like the bursting of a bubble. »
She worries that some people will make desperate decisions that could make their situation worse, like turning to debt consultants who charge for their services — when a credit repair clinic might help them for free — or going to a lender in high interest to consolidate their debt.
Examine various scenarios
For millennials, who came of age in the years before the 2008-2009 financial crisis and are now raising children of their own, low interest rates have been the reality for most of their adult lives. .
Experts say it’s important to understand the structure of debt, because higher lending rates mean less of the payment goes to the principal, and more goes to the interest. The monthly mortgage payment might not look that different, but a smaller portion of it will pay off the principal than before.
“Understanding the holistic picture of the household’s financial situation is sort of the first step, and then comes the examination of the various scenarios of the evolution of monthly expenses in the event of changes in interest rates”, notes Michael Greenberg, manager of portfolio at Franklin Templeton Investment Solutions.
Examining these scenarios could force tough decisions about spending and savings, he warns.
According to the results of a recent survey by the Angus Reid Institute, 34% of Canadians believe that interest rate hikes would have a minor negative effect on them, 25% believe that the impact would be very negative, 22% believe that it would have no effect for them and 6% see it as a positive element.
More than half of those who identify as “struggling” think a jump in rates would be very bad news for their household, and another quarter expect it to have a minor negative impact.
The survey also found that low-income respondents were more likely to believe that a rate increase would not be in their best interests.
Savers and seniors on fixed incomes would benefit from higher rates and some Canadians are in a good position heading into the rate hike cycle, if they continued to work during the pandemic and repaid their debts through their accumulated savings.
“There seem to be two sides to how people have weathered the pandemic economically,” said Kristi Ashcroft, senior vice president and chief product officer at Mackenzie Investments.
Rising wage growth, strong job markets and a possible drop in inflation mean this shouldn’t be too much of a concern for the economy or people as a whole, Ms. Greenberg.
“But these average figures hide some specific weak points within the market and the economy,” he warns.
No 1980s revival
While rate hikes may come as a shock, it won’t be like the late 1970s to mid-1980s when interest rates soared above 12%, he adds. .
One benefit this time around is that many homeowners have amassed a lot of equity through capital gains from their homes, which they can leverage, said Beata Caranci, chief economist at TD Bank.
Those facing renewals might see if they can extend the amortization period to get some payment relief.
Stress tests required by the financial services regulator will also help cushion the blow as mortgage borrowers have had to qualify at much higher interest rates, M notes.me Depleted.
“These people don’t necessarily need to do anything about higher interest rates because their income has already been checked against a higher interest rate. »