The time to budget and negotiate loans is now

Interest rates continue to rise, affecting loans and debt. Experts explain what this means and how you can try to limit its impact.

Canada is facing its largest rise in inflation since January 1983. To help combat this, the Bank of Canada has increased the country’s interest rate four times since March. Mid-July’s benchmark increase rate was raised a full percentage point to 2.5 per cent, the biggest one-time increase in more than 20 years.

With inflation now at 8.1 per cent, Canadians are increasing personal debt to supplement costs, with credit card spending rising 17.5 per cent in the first quarter of 2022.

“We’re seeing people spending on services that have been restricted during COVID,” says David-Alexandre Brassard, chief economist at CPA Canada. “People are travelling, they’re going to restaurants and we’re not seeing consumer spending trending down just yet.”

The impact of rising rates

The latest percentage increase could have a big impact on people’s finances, especially when it comes to the type of debt people carry, says FCPA Robert Hunt, licensed insolvency trustee and managing partner at Grant Thornton Limited.

For instance, people with variable debt such as credit cards, lines of credit and variable mortgages have interest rates tied to the Bank of Canada’s rates–and these rates are immediately affected. “When the Bank of Canada’s rate goes up, then the amount of interest in your payments go up,” he says. “When rates go down, the amount of interest in your payments goes down. If you have debt that has a variable rate associated with it, you can expect to see your payments increase.”

For those who have fixed rates of debt–such as a five-year mortgage that is locked in–this rise in interest rate will take effect only when it comes time to renew the loan. “The amount of your monthly payments will be based upon the interest rates that you can secure at that time,” says Hunt. And, if interest rates have gone up, so will your monthly payments.

How to approach debt

Household debt is expected to rise with experts anticipating mortgage payments may go up by 30 per cent over the next five years.

When it comes to borrowing–especially for those with fixed rates–Hunt explains that the onus falls on the consumer to negotiate a new agreement with their lender to secure a better rate.

“Some lending institutions will allow you to lock in your new interest rate a little bit in advance of your actual renewal date,” he says. “You have to address that question with your lender to find out what options they have.”

Consumers must also consider whether to choose fixed or variable lending.

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“That decision is really about how much risk people are willing to take, since interest rates may actually go back down or even lower than when locking them in,” he says. “Typically, you do pay a bit of a premium for locking your rate in versus floating. But it does buy peace of mind for people to help them know they can afford to service the debt that they’ve got.”

Each decision is personal and must be weighed against individual financial circumstances.

What you can do

Making a budget is the first step. “Really make sure you understand what money you have coming in, where your money’s going out and what you have left over at the end to service all of your debt,” says Hunt. “With some types of debt, like a mortgage, even a small increase in the interest rate can really add up to a big difference in your monthly payment or the amount of interest you pay over the term of the mortgage.”

Spending on luxuries, Brassard says, should be the first thing trimmed from a budget. “With the increased inflation rate, we’re seeing that hotels and restaurants are increasing their prices. Try to cut back on these things this summer,” he says.

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For those with large loans, such as student debt or lines of credit, reducing debt by any amount is advised. If you are struggling financially, do the most you can to limit debt in your situation. “At the very minimum, make sure you’re making your minimum payments on your debt,” says Hunt. “You want to reduce your highest cost debt as much as you can first, so that you’re paying the least amount of interest in total.”

Brassard agrees. “If you do need to go into debt, try for debt that is less expensive,” he says. “Credit card debt is the last one we’d suggest because of its high interest rate.”

With inflation on the rise, both experts agree that being financially prepared will help create a better outcome. “How you will be impacted,” Brassard says, “depends on what kind of loans you have.”

This makes it a good opportunity to review your budget and debt levels, and determine what next steps might be needed. Whether that’s reducing your spending or looking for lower interest debt products, it’s important to review all your options.