How do rising interest rates affect you?

Anyone with a variable rate mortgage in Canada understands the impact of rising interest rates. A rate hike can either cause borrowers’ debt payments to climb or reduce the amount of principal their mortgage payments pay off. Interest rate rises are caused when the Bank of Canada decides to increase its overnight rate, which is a short-term interest rate that factors into lending costs. Depending on the economic circumstances, interest rates can rise substantially over a year.

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Most people are aware that rising interest rates have an impact on mortgage costs: variable rates typically rise in line with the overnight rate, and it can also become more expensive to renew a fixed rate mortgage. However, higher interest rates can impact other aspects of our lives as well. 

Borrowing becomes more expensive

One of the biggest changes is to the cost of variable-rate non-mortgage credit, like home equity loans or lines of credit, which can make up a big chunk of people’s monthly costs.

When interest rates increase, consumer behaviour can change (higher interest rates can lead to less discretionary income) and that could have an impact on the Canadian economy. For example, people might think twice about how often they go out for dinner, whether to take a vacation or how much to spend around the holiday season.

Businesses must pay more, too

Borrowing costs don’t just rise for individuals, they climb for companies, too. One of the reasons why the Bank of Canada sometimes lowers rates is to encourage businesses to invest in their operations.

Rising interest rates mean business owners have to pay more to borrow money. Also, if consumers do spend less, then businesses, particularly ones that sell more discretionary items, could see falling sales.

The housing market may cool off

Higher interest rates can have an immediate impact on the demand for homes. Mortgage payments typically become higher for both variable and fixed rate on renewal. Qualifying for a mortgage becomes more difficult and can therefore reduce the number of new homebuyers in the market, which would reduce overall demand. 

Inflation should start to go down

Rising interest rates also have positive impacts for consumers and investors. When borrowing money becomes more expensive, consumers tend to spend less and therefore reduce the demand for certain goods. This reduction in demand normally leads to a drop in prices, which in turn reduces inflation.  

Savings can grow faster

There is another big benefit to rising interest rates: investors may be able to earn more money. The interest on bank savings accounts and guaranteed investment certificates (GICs), which fall whenever rates drop, should eventually rise as the overnight rate increases, meaning people can earn more money on their savings accounts.

Also, higher interest rates are a sign of economic growth: if the economy does continue to expand then that’s good for business and, potentially, stock prices. Anyone drawing income from their investments ought to see more.

A big impact on bonds

Investors also need to pay attention to rising interest rates. When rates climb, bond prices fall. This is because people would rather buy a bond with a higher yield (fixed income yields tend to rise when interest rates increase), and that makes existing bonds less attractive to investors who may sell them to buy new, higher interest bonds. Since many Canadians own some bonds, they could see losses in that part of their portfolio.

However, when that bond matures, the investor can now buy new bonds at higher yields. Anybody with a bond portfolio could see some capital losses, but on the flipside, the income they earn should rise in the future.

Some sectors could struggle

Certain sectors, such as real estate investment trusts, utilities and other industries with companies that pay high dividends, might take a hit. When bond yields fall, these sectors become popular with investors who are looking for investments with strong payouts.

When fixed income yields are rising, these equities start to become less attractive for dividend-seeking individuals, as they’d prefer to buy a well-paying, but less risky bond to a more volatile stock. The higher rates go, the lower the demand could be for these sectors. 

What should you do during periods of rising interest rates?

You should speak with an IG advisor to discuss how rising interest rates might impact your portfolio. They can provide advice and suggestions to deliver better returns in a higher-rate environment.

If you don’t have an IG advisor, you can find one here

 

Written and published by IG Wealth Management as a general source of information only, believed to be accurate as of the date of publishing.  Not intended as a solicitation to buy or sell specific investments, or to provide tax, legal or investment advice.