The era of fantastically low interest rates ended Wednesday.
The Bank of Canada increased its influential overnight rate by just 0.25 per cent, but the cumulative increase in the past 12 months is a full percentage point. Rates are still low, but they’re no longer a gift to borrowers and a saver’s nightmare. Adjust your finances to this new reality by taking these five steps:
Recognize your HELOC for the bloodsucker it is
Home equity lines of credit are priced off the prime rate, which banks and other lenders set in relation to the Bank of Canada’s overnight rate. If you have a HELOC, expect the interest cost after Wednesday’s rate increase to be in the range of 4 per cent to 5 per cent. This is based on a newly increased prime rate of 3.7 per cent plus markups ranging from 0.5 per cent to 1 per cent, depending on your lender.
A HELOC allows you to ignore the principal and just pay interest every month. In the days when rates were at rock bottom, this was an unwise but livable strategy. Now, HELOCs are a bloodsucker. Pay down what you owe to reduce the damage.
Resist the real estate sector’s attempts to reflate the industry
The latest rate increase will make variable-rate mortgages more expensive. Fixed-rate mortgages are influenced by what’s happening in the bond market, where the rate on the five-year bonds issued by the federal government to finance its operations has risen to 2.1 per cent from 1.45 per cent a year ago.
In cities with expensive housing, higher mortgage rates will curb demand. The real estate industry is trying not to look worried.
Realtor Royal LePage issued a forecast this week that house prices will climb significantly in the second half of the year. On CanadaMortgageNews.ca, the most recent headline as of earlier this week declared: Real Estate Rebounds in June As Expected. Home buyers, judge your purchase by what you can afford in a rising-rate world, not on the real estate industry’s self-interested forecasts of a hotter market to come. The definitive home affordability tool is The Globe and Mail’s Real Life Ratio Calculator.
Beware the sting of the variable-rate mortgage
Variable-rate mortgages are like HELOCs in that they are set using the prime rate as a base. This pricing has resulted in substantially cheaper rates than you can get with a five-year fixed-rate mortgage. About three-quarters of mortgages on homes purchased in the past couple of years are fixed rate, but interest in the VR option has understandably been growing.
The gap between variable- and fixed-rate mortgages with a five-year term will still be significant after the latest Bank of Canada move, but you need to be a certain sort of person to take advantage. Ask yourself whether you can handle the cost and stress of having your mortgage costs rise every time the Bank of Canada raises rates.
There’s no shame in taking a five-year fixed and likely paying a bit more in interest. It’s aggravation insurance.
Recognize that you’re getting hosed with most high-rate savings accounts
The most disappointing aspect of the rate increase over the past year is the lack of meaningful increases in returns from high-rate savings accounts. While banks have been increasing lending rates in lockstep with the Bank of Canada, they have been lagging on savings.
You can get 2 per cent to 2.3 per cent from a few players including Alterna Bank and EQ Bank, both of which are members of Canada Deposit Insurance Corp. (CDIC). But there are far too many banks paying something in the low 1-per-cent range, which is roughly half the current level of inflation.
The Canadian High Interest Savings Bank Accounts website has a chart of banks offering the best rates. Use it to make sure you’re not getting hosed.
Consider one-year GICs for savings
Finally, some positive news for savers and conservative investors. Guaranteed investment certificates with a one-year term happen to be a sweet spot right now. Oaken Financial has a 2.8-per-cent one-year GIC available, and it offers CDIC protection.
Value alert for clients of the online banks Tangerine and Simplii Financial – both offer a weak rate of 1.1 per cent on savings, but an excellent rate of 2.5 per cent on one-year GICs. If you can lock up your money for a year and want zero risk, this is worth a look.
Rob Carrick