Insights & advice
What happens when interest rates rise?
May 2022 - 15 min read
Interest rates are rising, and expected to rise further, in Canada
Rising interest rates may have an impact on your daily life
Higher interest rates can be beneficial – but may also have a downside
What’s in this article?
The benefits, and downsides, of a higher interest rate in Canada
If you have a mortgage or other loans, rising interest rates are something to keep an eye on. There may be ways to take advantage of the situation.
Interest rates slowly creeping up
In April 2022, the Bank of Canada raised its benchmark interest rate to 1%. This follows a hike in March 2022, when the Bank of Canada raised its benchmark interest rate to 0.50%. That marked the first time they have raised rates since 2018. In 2020 they actually cut the rate from 1.75% to 0.25% in a bid to boost the economy during the pandemic.
The Bank of Canada's move to raise its lending rate is significant, but it remains relatively low. For example, in the early 1990s the interest rate was roughly 10 times what it is today, and it was even higher in the 1980s.
When will interest rates rise?
It’s hard to know for sure.
When the government wants to encourage people to borrow money (a surplus of credit, if you will), they lower interest rates. This usually happens in challenging economic times when they’re looking to stimulate the economy by making it easier for people to spend.
When the government wants to discourage borrowing (a shortage of credit), they raise interest rates to make it more expensive to do so. This usually happens when they’re looking to tackle inflation.
Remember: Lending money involves a risk for the lender that the borrower might not pay them back. Interest is their “reward” for taking on that risk. Since you’re more likely to pay it back when times are good, they’re taking on less risk, and so their reward is lower. In challenging or uncertain times, the reverse applies.
What causes interest rates to go up?
Like many other market factors, interest rates are driven by supply and demand. In this case, it’s the supply and demand for credit.
How Canadians are dealing with higher rates
Higher interest rates are affecting Canadians in different ways, depending on their circumstances.
For example, Canada's housing market, which has been very hot for a few years now, may also be cooling off as higher interest rates make mortgage payments go up. This is mixed news if you’re trying to get into the market: Prices may become more affordable, but you may pay a higher mortgage interest rate than before.
How higher interest rates may affect your loans
Higher interest rates make loans and mortgages more expensive. Homeowners in cities with high-priced real estate, like Vancouver and Toronto, could pay hundreds of dollars more on regular mortgage payments. Higher interest rates also affect lines of credit as well as car and student loans.
If you have a student loan, you can expect the cost of paying off your loan to increase along with the interest rate.
The benefits of higher interest rates
Higher interest rates can be good news. The savings in a "high-interest" bank account could grow faster. Also, many fixed-rate investments, like guaranteed interest options or guaranteed investment certificates (GICs), could give you higher returns. You can also work with an advisor to update your mutual funds and segregated funds policy to help you take advantage of higher interest rates.
There are some simple ways to make the most of rising interest rates, or at least limit their negative impact. For example, if you have an open mortgage, look at changing it to a closed mortgage. Unlike an open mortgage, a closed mortgage won't be affected by interest rate changes.
Higher interest rates can also help curb inflation, which has risen sharply over the last year. In February 2022, for example, consumer prices rose 5.7% year-over-year. This is the biggest jump since 1991. Higher rates may help to slow this because when money is more expensive to borrow it can cut down on people’s spending, which can in turn slow inflation.
For the time being, interest rates aren't exactly rising quickly, meaning the total return on your investments will likely remain small. Eventually, however, a rising interest rate could mean more income for your investment portfolio, especially those that are fixed income, like bonds and GICs. (Your fixed-income investments are also an important balance to any investments in stocks, particularly when the market takes a downturn).
Take some time to look at your financial situation, and evaluate whether you need to revisit your budget ahead of any potential future interest rate changes.
You can also have a talk with an advisor about adjusting your savings and investments to make the most of rising interest rates. They may be able to help you find solutions that give a better return as rates move up.
The information provided is accurate to the best of our knowledge as of the date of publication. This information is general in nature, and is intended for educational purposes only.