The drop in interest rates announced at the beginning of June was expected by economists and households alike. The Canadian economy does not have the strength required to sustain high key rates for so long, in particular because Canadian households remain among the most indebted in developed countries. As for the speed of the key rate rise, the data is less clear, one of the complex challenges for the Bank of Canada being to avoid a speculative revival of the real estate market.
Knowing that the drop in rates will probably be very controlled and largely gradual, how should you adapt your personal financial planning? Let us focus here on the expected effects of this first rate cut, and subsequent cuts.
Effects on your budget
Don’t jump for joy too quickly if you are part of half of mortgage borrowers who have still not renewed their loan since the increases began. The mortgage rates currently offered will not magically decrease. So, your budget should still account for a higher mortgage payment than in the past. Indeed, renewal in the coming months for those who have still not done so will still be done at higher rates than before July 2022.
The rate cuts will have a more direct effect on variable rate users, who will be able to repay more capital than in recent months. That being said, even if rates are falling, the fact is that a smaller proportion — or little or even nothing! — capital on the balance has been repaid in recent years on variable rate loans. My advice here would be to consider the higher payment as the new “normal” payment. This will allow you to catch up on this repayment delay on your initial schedule.
In short, for both fixed rate and variable rate borrowers, the recent drop in rates does not eliminate the need for a revised budget to take into account housing costs that are much higher than in the past. For families with more limited incomes, this will continue to create some headaches and require discipline. People who are better off financially should still ensure that rising housing costs do not sneakily translate into a reduction in their investments, even if it means restricting discretionary spending.
Furthermore, if you have major work to be done, such as renovations, in the next 12 to 24 months, it is not a bad idea to focus on savings more than on financing. In fact, the interest rates paid on savings currently remain attractive. A little discipline in saving and preparation will allow you to avoid resorting to mortgage margins, the rates of which should remain relatively high, compared to what you have known in the past — at least, for the youngest among you .
Effects on your wallet
First, let’s warmly welcome the return of yield in the fixed income portion of your portfolio, which was badly hit in 2022. Interest rate cuts generally increase bond prices on secondary markets since new bonds issued at lower rates become less attractive, consequently increasing the value of those already on the market.
It is simply the interplay of supply and demand that sets prices. If you can envisage more gains with the drop in rates, you must also understand that rate cuts also mean a drop in yield, because the rate of new coupons is falling. The yield on your bond portfolio will also vary greatly depending on the maturity of the bonds it contains. Duration (which measures the sensitivity of a bond or a portfolio of bonds to changes in interest rates) is very sensitive to movements in interest rates: in theory, a fall in rates favors a longer duration .
The stocks held in your portfolio are also influenced by changes in interest rates. Decreasing borrowing costs will give some breathing room to more indebted companies, such as those that are growing or those in sectors requiring a lot of investment. The value of the shares should therefore increase since it is based on the forecast of future profits.
Concretely, this market recovery increases the cumulative return on your investments and allows you to check whether the balance of your accounts follows the projected value in your last financial planning report.
Effects on retirement planning?
The cost of living remains high in Canada, but inflation is currently relatively controlled, excluding housing expenses. So, if you are already retired with one or more paid residences, your retirement is far from being compromised. If disbursement scenarios have been carried out with security projection standards and robustness tests have been carried out, you can regain your optimism (if you had lost it).
My advice remains to ensure solid financial security before disbursing assets quickly to support your children’s access to property.
Moreover, for the cohort of first buyers or renters, this rate reduction, but especially the next ones, could lead to new episodes of real estate overheating (what the Bank of Canada names as its main challenge). It is obvious that access to property is a problem that has significant repercussions on your long-term planning. Investment discipline should be in place to avoid the house becoming the only asset that can be used in retirement, since it is far from liquid.