How to make the most of an interest rate drop
5 things you can do to save cash today and tomorrow
Bank interest rates are like a roller coaster. There's not much more you can do but strap yourself in, hold on tight and see where the ride leads.
That attitude, however, season after season and year after year, can cost you a lot of money.
Set by the Bank of Canada, what’s known as the overnight rate is an interest rate used primarily to keep inflation in check, says JR Shaw School of Business Finance instructor Tannya McBride (Finance ’07). Higher rates make borrowing more expensive, which curtails spending, which should then lower the demand for goods and services, keeping prices in check.
“We’ve been very spoiled in the last few years,” says McBride. “Interest rates have been extremely low. The problem is that, in these years of low rates, people have maxed their credit.”
Household debt is at an all-time high, she points out. Should Bank of Canada interest rates rise significantly, a perfect storm may be on the horizon.
“It’s still not too late to do something about it,” says McBride. Here are the five things she says you can do today to keep your finances on track.
1. Mind your mortgage
The Bank of Canada interest rate is worked into your mortgage as a cost of doing business. When it goes up, banks’ prime lending rates tend to follow, often resulting in higher mortgage rates and other loans.
If a fixed rate looks better than the ups and downs (well, mostly ups, now) of your variable rate mortgage, talk to your bank about locking in, says McBride. Or, if your fixed rate is nearing the end of its term, ask to renew early, before the rate hike.
“It can be a little bit deceiving.”
“A third possibility is refinancing your mortgage,” says McBride. In some cases, it may be cheaper to break the contract, pay the associated penalty and start again. The bank can do the math to help you decide.
Do nothing and you may be convinced that nothing actually changed anyway. But look closely. A bank won’t adjust your payments if rates rise; instead, it adjusts the amortization.
“It can be a little bit deceiving,” says McBride. “They prolong the number of years it takes you to pay it.”
2. Clear your credit cards
A Bank of Canada interest rate hike won’t affect what you owe on your credit cards, but that doesn’t mean you should neglect them.
“In anticipation of a hike, pay down your consumer credit,” says McBride. “Even though the [credit card rates] won’t increase, all the money that you’re going to save can be put toward your increased mortgage.” By managing one stress on your finances, “you free up quite a bit of cash” to deal with another.
"All the money that you’re going to save can be put toward your increased mortgage.”
3. Leave no loan alone
Lines of credit and variable interest loans such as those for cars or other large purchases react to Bank of Canada rate increases in the same way mortgages do. If they look as though they’re about to get unwieldy, consider a consolidation loan. Banks will bundle up your debt under an often lower fixed rate. “Your payments decrease quite a bit,” says McBride.
4. Buy now!
Though this advice sounds as if it runs counter to the belt-tightening theme of this article, McBride acknowledges that people need to buy stuff.
When it’s big stuff, stuff that requires a loan, hit up the bank sooner than later if a rate hike is within view.
“Don’t procrastinate on purchases.”
“Don’t procrastinate on purchases,” says McBride. “If you have the ability to do it now while we’re at a lower rate, might as well do it and gain a extra time at the lower interest rate.”
5. Don’t get taken by surprise
Rate hikes and the anticipation of them are hot topics, making them easy to stay on top of.
“Keep yourself informed,” says McBride. Know the numbers and get a sense of where they may be headed.
And if you’re not sure how an increase will hit your finances, “go see your banker. Find out what options are available to you.”