Interest Rate Hikes are Not All Doom and Gloom for Consumers
Q: I’m going into my final year of university this fall and I’m looking forward to starting my career next year in the financial services industry. The one thing I’m not looking forward to is figuring out how I’m going to pay back the $30,000 in student loans I’ll owe when I graduate. It’s frustrating that after a long period of ultralow interest rates, the rates have increased, and experts are predicting future increases. This means I’ll end up paying more interest on my student loans and so will everyone else with outstanding debt. How can this be good for consumers and our economy? ~ Jake
A: You are right; you will end up paying additional interest on your student loans as a result of recent interest rate hikes in Canada, and so will everyone else with variable rate loans, lines of credit and mortgages. You can reduce the overall amount of interest you will pay on your student loan by reducing the repayment term of your loan. While it takes some effort and sacrifice, many students are able to pay off their student loans in five years or less by being careful with their money and directing additional funds to pay down their debt.
The best time to map out a plan to pay down your debt is at the start of your career. To be successful you’ll need to be mindful not to let lifestyle expense get in the way. We have some great tools and resources on our website to help you. Get started with understanding what a budget is, why it’s important, and how to guestimate your living costs.
While interest rate increases may not be welcome news to you at this stage in your life, consumers and our economy benefit when historical average interest rates exist in the marketplace. Here are five good reasons why interest rate hikes are not all doom and gloom for consumers:
1. Higher interest rates mean higher returns for savers
Canadians have only averaged an annual savings rate of four to five per cent of their annual earnings for the last few years. At that rate very few of us will reach the amount of savings we will need in our retirement. It’s hard to get excited about saving when interest rates on savings accounts and GICs are so low. A higher interest rate will lead to higher rates being offered by financial institutions on savings accounts which will motivate consumers to get back into the savings game.
2. Higher lending rates will curb our appetite to take on more debt
Canadians are carrying a record amount of debt ($1.8 trillion and growing) which isn’t surprising when you consider the low borrowing costs over the last 10+ years. Low interest rates have made it appealing for consumers to borrow, as well as to borrow more than what they would have in higher interest rate environments. Higher borrowing costs will have the opposite effect; consumers will borrow less and hopefully pause before taking on additional debt. One of the key reasons consumers find it difficult to set money aside for saving is due to the large bite debt takes out of their paycheques. Less debt means you get to keep more of the money you earn in the future.
3. Greener pastures for retirees
Low interest rates have not been kind to seniors living on a modest budget. One of the biggest challenges for seniors without defined benefit pension plans is that they can’t afford to take on a lot of risk with their retirement funds. They look for safety and stability with their investment funds and turn to GICs and bonds to accomplish this. Unfortunately, lower risk investments like GICs and bonds have generated low rates of return over the past ten years, leaving seniors with declining levels of interest income. Interest rate increases will provide seniors with the opportunity to generate higher interest income and give them greater ability to manage rising costs.
For consumers who are or will be receiving a pension when they retire it means their pension plan fund will be in a better position to meet future pension payout requirements as a result of higher returns on the fixed income portion of the plan. With people living longer one of the greatest financial risks they will face in retirement is running out of money, higher savings rates and higher bond returns will help address this growing concern.
4. Higher interest rates will slow the rise in housing costs
Whether or not the next generation will be able to afford their own homes is a question that is top of mind with millions of Canadians today. Interest rates play a pivotal role in determining the overall amount of a mortgage a person may qualify for. Higher mortgage rates decrease housing affordability. This means that fewer people will qualify for mortgages and be in a position to purchase a home until they have saved up a bigger down payment and/or have had an increase in their household income. The result is a softer real estate market. We are already seeing this as a result of a new federal policy that requires consumers to qualify for a mortgage based on higher fixed rates. Single detached house prices in our large metropolitan cities like Vancouver and Toronto have dropped and condominium and townhouses are stabilizing. This is good news for future homeowners.
5. Higher rates increase the ability of our federal government to stimulate the economy
The Bank of Canada, which sets our monetary policy, pays close attention to our economy and inflation. In times of financial distress, many countries like Canada will ease interest rates; it’s one tool they use to help stimulate the economy. Lower borrowing rates encourage companies and consumers to borrow and spend. This leads to an improved economy, increases the number of people who are able to find work, and helps to maintain reasonable wage levels. In order to accomplish this, we need to have interest rates at a reasonable level which is why governments like Canada are motivated to carefully move interest rates upward and protect our economy.
The bottom line on interest rate hikes
There’s a fine line between interest rates that are too high or too low and how they may help one segment of our population and hurt another. As consumers we can’t control the upward or downward direction of interest rates but we can control the impact of interest rate shifts by making careful borrowing and saving decisions. Living within your means and planning for contingencies and your future are critically important regardless of which way interest rates are moving.