Rising interest rates have been a hot topic the past few months. When you add high inflation and stock market volatility that we are seeing this year, we understand why many Canadians have questions and concerns about how to cope financially.
Q: How much higher could interest rates go?
A: The Bank of Canada’s interest rate increases this year are a direct result of our high level of inflation. The government’s target annual inflation rate is around 2%, which is considered healthy for our economy. But, inflation has been much higher in 2022, peaking at 8.1% in the summer, a 39 year high! The main tool the government has to curb inflation is to increase interest rates, which has a dampening effect on the economy, and in turn should reduce the rate of inflation.
And in the past month or so the Bank of Canada’s actions are starting to show positive results, with last month’s numbers reducing to 7% annual inflation. Will this mean the rate hikes are over? I doubt it, the government will likely need to see the annual inflation rate continue to reduce before they feel they can maintain interest rates for a period of time. Prepare for the potential of further rate increases in October.
Canadians have to try and make ends meet with increased costs for groceries and many other goods and services. Gas prices at least have come down a bit from their highs earlier this year, so that has provided us with a bit of relief. In these times of uncertainly it is important that people are extra careful with their personal finances. Budgeting becomes even more important in order to ensure you can meet your obligations.
The implications for borrowers
We’ve had over a decade of historic low mortgage and loan rates. These low borrowing rates helped fuel rising house prices, as people could afford to borrow more money. Many borrowers selected a variable rate mortgage, which was tied to the very low prime rate at their financial institution. But now that prime has increased about 300% since March, those variable mortgage and other variable loan payments have risen accordingly. And of course the kicker is a lot more of your payment is going to interest.
Considering a fixed-term mortgage and/or loan helps provide certainty for borrowers as you’ll know exactly how much your payment will be for the term you select. Having that certainty also helps you balance your household budget. Coupled with the strong possibility of another Bank of Canada rate increase this year, and fixed term interest rates may be a safer bet for many people.
The mortgage stress test, which some borrowers and even some folks in the real estate business complained about when it first came into effect, has proven to be a prudent action. Those borrowers who had to qualify for a mortgage at a rate of at least 2% higher than the actual rate they were given, are now finding that their variable interest rate is...at least 2% or higher than the rate they were initially given! The good news is they should be able to afford the higher payment they now have. Those with a fixed rate mortgage have the same rate and payment until their term is up, so most have some time before they will see an increase in their payments, and ‘hopefully’ rates may be down a bit if they have a couple of years before their renewal.
Q: Stock market declines in 2022 have affected people’s investments. What should investors be thinking about?
A: With so much recent volatility many people are feeling confused about the stock market — and wondering if they should stay invested.
Like the long period of record low interest rates that just ended, we’ve also seen an equally long streak of stock market gains since 2008. There’s a whole generation of investors that have only seen the market go up. Even COVID couldn’t slow it down except for a few months of a downturn that was quickly reversed.
But a number of factors, including the ongoing war in Ukraine, supply shortages, inflation, higher interest rates, and the recent signs of a recession, have created a picture of continued volatility in the markets.
At the time of this writing, Friday September 23rd, the markets are coming off a very poor week. The DOW in the US just tumbled by nearly 500 points today (Friday) to close at it’s lowest level of the year. The TSX in Canada faired even worse, falling over 500 points.
Try not to panic if your investment portfolio is down. Emotion leads to bad decisions. Markets have down periods, and we are in one this year. But, remember that markets will go back up. Historically the TSX has returned an average of 9.3% annually since 1960. That’s 62 years. There’s no real loss unless you sell, and if you do sell now, you won’t gain back when the markets do eventually increase.
Do you have questions about interest rates, the markets or your personal finances? Email your questions to Dave at FinanceFriday@FirstOntario.com or find him on Twitter at Finance_Friday.
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