Rising interest rates and you: What does it all mean?

If you have been reading the news lately, you may know that the Bank of Canada increased the prime rate again earlier in January. You may also know that this is actually the third time we saw an increase in the prime rate over the past year. What does an increase in the prime rate have to do with you, as a consumer? Great question! It will be helpful for us to take some time in order to understand the prime interest rate and how this change can affect our everyday lives.

source: tradingeconomics.com

According to general macroeconomic theory, there are a variety of effects that result from rising interest rates. In this post, we will talk about two of the effects that will be most relevant to the regular consumer: a stronger dollar, and more expensive debt.

Rising interest rates lead to a stronger dollar

When Canada raises the interest rates, it encourages more money to flow into our country, particularly from economies with lower stability, due to the fact that people want to mitigate risk. Since there is theoretically more demand for the Canadian dollar, the price of our dollar will increase relative to the currency of other countries.

For those who like to do a lot of shopping in the United States, this could mean that you’re getting slightly better deals in the near future. That being said, however, we should keep in mind that the US is also looking to increase their interest rates, which means the relative value of our currencies will stay similar. Thus, to take advantage of a stronger dollar, you may have to fly out somewhere much further away!

Holding debt becomes more expensive

For most people, the effect of rising interest rates on debt will probably be the most profound. Think about which forms of debt you have on a daily basis. You may have a mortgage, a car loan, a business loan, credit cards, or personal lines of credit. Each of these may be affected by a rising interest rate.

One key factor is whether your rates are locked-in or variable. We suggest that you take a look at your various loans and lines of credit to determine which kind you have. If your rate is locked-in, that means the interest rate on your loan won’t change, until time of renewal. If your rate is variable (some institutions may refer to it as “floating”) then you’ll have to budget accordingly, as your monthly payments will be increasing a little. Let’s take a look at an example:

If you had a $100,000 line of credit at a variable rate of prime + 1%, before the rate hike you would have had an interest rate of 3.2% + 1% = 4.2%. With the higher prime rate, you will now have an interest rate of 3.45% + 1% = 4.45%. This means that instead of paying $350 a month, you will now need to pay $375 a month in interest.

As always, it’s important to know that there is a difference between good debt and bad debt. In a rising interest rate environment, we should be even more diligent in making sure that the debt we decide to take on falls firmly under the “good debt” category.