The time to budget and negotiate loans is now

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Budgeting and debt reduction can help limit the impact of rising interest rates on personal finances (Getty Images/Jose Luis Pelaez Inc)

Canada is facing its biggest rise in inflation since January 1983. To help combat this, the Bank of Canada has raised the country’s interest rate four times since March. The mid-July benchmark rate of increase was raised a full percentage point to 2.5%, the largest one-time increase in more than 20 years. With inflation now at 8.1%, Canadians are taking on more debt to cover costs, with credit card spending up 17.5% in the first quarter of 2022.

“We are seeing people spending on services that have been restricted during COVID,” says David-Alexandre Brassard, chief economist at CPA Canada. “People are traveling, they are going to restaurants and we are not yet seeing a downward trend in consumer spending.”

THE IMPACT OF RISE IN RATES

The latest percentage increase could have a big impact on people’s finances, especially when it comes to the type of debt people are carrying, says FCPA Robert Hunt, Licensed Insolvency Trustee and Managing Partner at Grant Thornton Limited.

For example, people with variable debt such as variable credit cards, lines of credit and mortgages have interest rates tied to Bank of Canada rates, and these rates are immediately affected. “When the Bank of Canada rate goes up, the amount of interest on your payments goes up,” he says. “When rates go down, the amount of interest on your payments goes down. If you have variable rate debt, you can expect to see your payments increase.

For those with fixed debt ratios, such as a five-year locked-in mortgage, this interest rate hike will not take effect until the time comes to renew the loan. “The amount of your monthly payments will be based on the interest rates you can get at that time,” Hunt explains. And, if interest rates have increased, your monthly payments will also increase.

HOW TO APPROACH DEBT

Household debt is set to rise, with experts predicting mortgage payments could increase by 30% over the next five years.

When it comes to borrowing, especially for those with fixed rates, Hunt says it’s up to the consumer to negotiate a new deal with their lender to get a better rate.

“Some lending institutions will allow you to lock in your new interest rate shortly before your actual renewal date,” he says. “You need to discuss this with your lender to find out what options they have.”

Consumers also need to consider whether to choose fixed or variable loans.

“This decision is really about the level of risk that people are willing to take, because interest rates can actually go back down or even go down from where they were by locking in,” he says. “Typically, you pay a bit more to lock in your rate than to float it. But it reassures people to help them know that they can afford to repay the debt they have incurred.

Each decision is personal and should be weighed against individual financial circumstances.

WHAT YOU CAN DO

Making a budget is the first step. “Really make sure you understand the money you’re getting, where your money is going, and what you have left at the end to pay off all of your debt,” says Hunt. “With certain types of debt, like a mortgage, even a small increase in the interest rate can really make a big difference in your monthly payment or the amount of interest you pay over the term of the mortgage.”

Luxury spending, says Brassard, should be the first thing to cut from a budget. “As the inflation rate increases, we see that hotels and restaurants are increasing their prices. Try to reduce those things this summer,” he says.

For those with large loans, such as student debt or lines of credit, it is advisable to reduce the debt by any amount. If you are having financial difficulties, do everything you can to limit the debt in your situation. “At the very least, make sure you’re making your minimum payments on your debt,” Hunt says. “You want to reduce your most expensive debt as much as possible first, so that you pay the least amount of interest in total.”

Armband agrees. “If you need to get into debt, try cheaper debt,” he says. “Credit card debt is the last one we suggest because of its high interest rate.”

With inflation on the rise, both experts agree that being financially prepared will help create better results. “How you will be affected,” says Brassard, “depends on the type of loans you have.”

This makes it a good opportunity to review your budget and debt level, and determine any next steps that may be needed. Whether it’s cutting back on your expenses or looking for low-interest borrowing products, it’s important to consider all of your options.

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