Since peaking in July 2007, prior to the 2008 credit crisis, interest rates have fallen and have remained at their lowest level in two generations. Experts predict that this could be the year that interest rates finally start to increase. The question is, should we really care? Should we worry about high debt levels if interest rates are low?
Those same experts have predicted an interest rate increase every year since 2008, and they have missed the mark every year. It's clear the "experts" don't have a great track record in predicting the future.
Debt management professionals, like me, keep warning that if interest rates go up, borrowers are in big trouble. For example, your $400,000 variable rate mortgage at 3 per cent interest is costing you $1,892.98 per month, amortized over 25 years. If interest rates go back to where they were just six years ago, around 6 per cent, your monthly payment jumps to $2,559.23.
That's an extra $666 per month and in percentage terms your payment just increased by over 35 per cent.
Will your paycheque go up by 35 per cent this year? Not likely. Even a small increase in interest rates can put a serious dent in your monthly cash flow.
That's why, for the last five years, I've told everyone who will listen that now is the time to reduce your debt so that you are less vulnerable to an interest rate increase.
But what if I'm wrong?
What if interest rates stay low for the next five or 10 years?
"Experts" don't think it's possible, but it is. The Prime Rate has remained stuck at 3 per cent since September, 2009. We are now entering the sixth year where interest rates haven't budged.
Why couldn't they stay low for six more years?
Governments around the world are carrying massive levels of debt. Consumers are also severely indebted. The government can't let interest rates rise because it would throw the economy into a deep recession.
So if interest rates are likely to remain low for many more years, do you need to worry about carrying high levels of debt? Why bother paying off debt if you can borrow at low interest rates, and use the money to invest in the ever increasing stock market, or to buy a house that will likely go up in value?
That reasoning makes theoretical sense, but even with low interest rates forever, I still recommend keeping your personal debt levels low for the following reasons:
First, what happens if you lose your job, or your income drops? Even a low interest rate mortgage can be a burden if you have severely reduced cash flow. With no debt, you can survive a drop in income.
Second, for many people low interest rates are a myth. Your variable mortgage interest rate may be low, but what about your credit card? The standard interest rate on a basic no frills credit card remains at around 19 per cent, the same as it was 20 years ago. That's not a low interest rate, and carrying a balance on a credit card is financial suicide (don't get me started on super high interest rate finance company and payday loans).
Third, all debt limits your flexibility. If you have no debt it's a lot easier to take advantages of opportunities or make a life change. Need to borrow to take advantage of an investment opportunity? If you are already maxed out, forget it. Want to retire early, or even at all? Carrying debt into your senior years jeopardizes those plans.
Fourth, no debt gives you peace of mind. I've never met anyone who loses sleep at night worrying about not having enough debt.
And now for the final reason why lowering your debt is a prudent decision: eventually the experts predicting higher interest rates will finally be right.
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