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The Silver-Lining to Canada’s Rising Interest Rates Thumbnail

The Silver-Lining to Canada’s Rising Interest Rates

Yes, it’s true rising rates have negative effects – we all feel this, particularly when it comes to borrowing money. However, higher rates can also mean lower prices, faster savings growth and better returns on fixed-rate investments.

There is so much talk today surrounding the rising interest rates. If you’re carrying a variable-rate mortgage or have an outstanding balance on a line of credit, this talk may have you concerned, and rightly so.

But surprising as it might sound, there are a couple of ways in which rising interest rates can actually benefit your finances — if you know how to take advantage of them.

Why have interest rates gone up so much?

First, to understand why the Bank of Canada and other financial institutions have been raising rates, it helps to understand the effects of lower interest rates on the overall economy.

Over the last decade Canadians have enjoyed historically low interest rates, which has been a boon for borrowers. Low interest rates make it cheaper to borrow money which often results in an abundance of spending and less urgency towards saving. That’s because when you benefit from extremely low borrowing rates, the tradeoff is also extremely low rates being offered on savings accounts, and other savings vehicles like guaranteed investment certificates. You can’t have the best of both worlds. We wish it worked that way!

As Canadians borrow and spend, the economy grows. While economic growth is generally good, it can become unsustainable when demand outpaces supply, which is when inflation begins to rise beyond normal levels.

Sustained periods of high inflation typically prompt the Bank of Canada to raise its benchmark interest rate, and Canada’s other banks and financial institutions soon follow suit.

Benefits of rising interest rates

Temper inflation

In June 2022, the most recent data available, Canada’s annual inflation rate was at a record high of 8.1%, the highest since 1983. (www.thebankofcanada.ca) While it may be possible for people to scale back on non-essentials like streaming services or vacations, it’s harder to avoid the essentials like groceries and fuel prices.

One of the most significant benefits of rising interest rates is they tend to slow inflation. That’s because, when discouraged to borrow and encouraged to save, people typically begin to spend less money.

As people spend less, supply begins to exceed demand, which in turn causes prices to eventually decline. In an effort to encourage people to buy more goods, producers and retailers tend to lower prices. As costs decrease, inflation slows or even reverses course. 

Accelerated savings

When interest rates are low, borrowing power increases, and the benefit of stashing money in a savings account decrease. When interest rates trend upward, it’s good news for savers!

As the Bank of Canada increases its benchmark rate, slowly but surely, Canada’s major financial institutions respond by increasing interest paid on accounts like high-interest savings accounts.

Better interest rates and the magic of compound interest accelerate savings growth, which in turn encourages more saving.

Better returns on fixed-rate investments

As interest rates rise, fixed-rate investments like guaranteed investment certificates, and provincial and federal bonds, typically start to offer more competitive returns to encourage consumers to “lock in” their money for a set period of time. Over the last decade guaranteed interest certificates (GIC’s) offered offensively low rates, forcing risk adverse investors to settle for very minimal growth in their investment savings.

Because bonds and GICs are a fixed rate of return, they are generally a solid option for Canadians looking to capitalize on higher interest rates with minimal risk. For those looking to maximize their savings, GIC laddering (a strategy in which you purchase several GICs with different terms) can also be a good approach.

Thinning out crowded real estate market

Another silver lining of rising interest rates is the potential cooling effect they’re likely to have on the housing market.

Much has been written about Canada’s competitive real estate market, which was spurred in no small part to historically low rates. Lower mortgage interest rates made home loans easier to manage, and eager house hunters flooded the market. This demand encouraged sellers to increase their asking prices, making it harder for buyers to find an affordable property. Low interest rates made overpaying for a house in this hot market manageable for many, which here inlays another crisis, but that’s for another newsletter.

As interest rates begin to rise, mortgages will become more costly and less manageable. It will also become more difficult for potential homeowners to pass Canada’s mortgage stress test.

Increased costs and qualification requirements will cause some buyers to delay their plans to buy, which economists say should help stabilize the housing market. Fewer buyers will likely lead to less competition, which could make it easier for those with solid financing to find and purchase a home.