BUSINESS

Bank of Canada Hikes Interest Rate: Here's What This Means For You

The bank believes the economy is improving.

07/12/2017 10:03 EDT | Updated 07/12/2017 16:00 EDT
Chris Wattie / Reuters

The Bank of Canada announced Wednesday it's hiking its key lending rate to 0.75 per cent, from 0.5 per cent. It's the first time in nearly seven years that the central bank has raised borrowing costs for Canadians.

Here's why the bank made the move, what it means for you, and what happens next.

Why did the bank hike rates?

The Bank of Canada is worried about inflation making a comeback in the economy, and hiking interest rates is a proven tool for fighting inflation, which eats away at people's savings and reduces their spending power.

Right now Canada has very little inflation, but the economy has been growing at some of its fastest rates since before the financial crisis, and job growth has been stellar (351,000 jobs added in the past year). This sort of thing is usually followed by inflation, hence the bank's move.

Not everyone agrees it was the right move. Some of the more bearish analysts say Canadians have taken on too much debt to start raising rates now, and the move is bound to hurt consumers. They predict the Bank of Canada will halt any future moves to hike rates when that becomes apparent.

What happens now?

The banks will pass on the higher interest rate to borrowers. If you have a variable-rate mortgage or a home equity line of credit (HELOC), meaning a loan against the value of your home, your interest costs will rise as soon as your lender raises their rates. You will be paying more in interest costs and less towards the principal.

If you have a fixed-rate mortgage, your interest rate won't rise until it's time to renew. At renewal, you may find the mortgage rates offered to you are higher than last time around, and you are facing larger monthly payments.

Will this cause a housing correction?

All eyes will be on the housing market to see how it handles the increased cost of borrowing, but the experts say this 0.25-percentage-point hike isn't big enough to tank the market.

But this likely isn't the last rate hike, and the analyst consensus is for two more hikes before the end of 2018. If that were to happen, some borrowers could start to feel the pinch.

A recent survey from insolvency firm MNP Ltd. found 27 per cent of Canadians say they are already "in over their head" with mortgage debt, even before any rate hikes. Fully 44 per cent said they would be facing insolvency if their costs rose by $200 per month.

What can I do to protect myself from rising interest rates?

If you're worried that you won't be able to afford your loan(s) when rates rise, the first thing to do is stop borrowing any more money.

Secondly, if you have any leeway to make extra payments on your debt, do it. Take advantage of today's low rates to make sure you have less debt when rates rise.

If you are a would-be borrower considering a home or car loan, run your own "stress test" on your potential debt. Use an online mortgage or loan calculator to figure out what your debt would cost you if interest rates were to rise by, say two or three percentage points.

If you can still afford your debt at those rates, you're probably OK. If you can't afford it, consider a less expensive home or car.

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