The Bank of Canada could raise interest rates as early as mid-July. Who would higher interest rates benefit and who would they hurt?
After holding interest rates at record low levels for the past two years, the Bank of Canada (BoC) has dropped a number of hints over the past few weeks that it is ready to finally start increasing rates. Some economists believe the first hike could happen as soon as July 12, the next time the BoC will review its interest rate target.
Other experts believe the bank will wait a little longer. Ontario-based financial planning company TriDelta Financial, for example, sees a rate increase happening later this year or early in 2018, Lorne Zeiler, vice-president at the firm told Global News.
The consensus, though, is that interest rates are heading up.
There is also broad agreement that the BoC will move rates slowly and gradually. At first, the bank will likely boost rates by increments of only 0.25 of a percentage point, said Zeiler.
So what do higher rates mean for Canadians — who will benefit and who will lose?
Debtors vs. savers
The intuitive answer is that if you have a lot of liabilities and little in the way of savings, this will hurt you because higher interest rates make debt more expensive. Your monthly debt repayments may go up, and it may take you longer to pay down your debt. Conversely, if you have a lot of money saved up, banks will finally start paying you a bit more for parking your hard-earned cash with them.
Debtors with variable-rate loans will be the first to feel the pinch. The interest rate on this kind of debt, in fact, tends to move up or down according to where the BoC pegs its key interest rate. Canadians with variable-rate mortgages and lines of credit will soon face higher debt repayments.
On the other hand, an interest rate hike by the BoC would push up interest rates on guaranteed investment certificates (GICs), said Zeiler. GICs are a popular investment option that many Canadians use to save up for retirement.
The real divide between winners and losers from an interest rate increase, though, is likely between the housing haves and have-nots.
The trouble with homeowners
One-third of Canadians say they would worry if their mortgage payments went up by 10 per cent or more, according to a recent Ipsos poll conducted for RBC.
For homeowners with a variable mortgage rate of 2.5 per cent, a rate hike of as little as 0.25 of a percentage point (from 2.5 to 2.75) would constitute a 10 per cent increase in interest payments alone.
Canadians with fixed-rate mortgages wouldn’t feel the impact of higher rates until their loans come up for renewal. Over time, however, they would also face higher mortgage payments.
“The truth about debt in Canada is that many homeowners are not prepared to adjust to rising interest rates,” Rick Lunny, president and CEO of Manulife Bank of Canada said recently in a statement. (Lunny also noted many homeowners would be equally unprepared for unforeseen expenses or a loss of income.)
Even with interest rates at rock bottom, nearly a quarter of Canadian homeowners polled in a recent Manulife survey said they have experienced not having enough money to pay the bills at least once in the past 12 months.
Millennials will be hit hard
Younger homebuyers are particularly vulnerable. Millennials “saw their mortgage debt rise more than any other generation,” the report noted.
People in their 20s and 30s who just purchased a home will face higher rates at a time when they are just starting to hack away at this mountain of mortgage debt, said Paul Kershaw, a professor at the University of British Columbia and founder of Generation Squeeze, a group that advocates for policies to help young Canadians.
“I feel particularly for those who bought in the last few years,” Kershaw told Global News.
Generation Squeeze has proposed tax credits for mortgage interest costs incurred by homeowners under the age of 40 as a way of mitigating the impact of rising rates on younger generations.
Not just millennials
Across all age groups, though, those who have borrowed “aggressively” against their homes will likely scramble, said Zeiler.
Older generations, who have seen the equity in their homes rise along with home prices, have been using home equity loans to finance anything from day-to-day expenses to home renovations. But most home equity loans come with variable-rate interest that would rise with a BoC rate hike.
Also, nearly 40 per cent of baby boomers still have mortgage debt, according to Manulife.
Why housing have-nots could win
Higher interest rates could also cause home prices to stagnate or decline.
Policymakers have been trying to cool down housing prices in a number of ways in recent years, from tighter federal mortgage regulations to provincial-level taxes on foreign homebuyers in Vancouver and Toronto. So far, the housing market “seemed to withstand almost all of them,” but higher interest rates would be “another factor that could hurt it,” said Zeiler.
Although it’s hard to predict exactly what the impact of higher rates will be on property values, if housing prices start declining,”there will be a moment when many will celebrate,” Kershaw told Global News.
Those popping the champagne corks will mostly be millennials and Gen Xers who have been shut out of the housing market so far.
As of 2016, it took a whopping 13 years in average-wage full-time jobs for Canadians to save for a 20 per cent down payment on a house, according to Generation Squeeze. In the late 1970s, it only took five years.
Higher interest rates could help bring home prices back within reach, said Kershaw.
Of course, higher rates would also make mortgages more costly, but governments could help new homebuyers with targeted financial aid such as the age-based tax credits on mortgage interest payments, he argued.
Meanwhile, a cooling housing market would be bad news for most Canadians who already own a home.
Over 4o per cent of boomers’ home equity accounted for more than 60 per cent of household wealth, according to Manulife. For one in five, home equity is 80 per cent of household wealth.
Many will likely need to downsize in order to free up enough cash for retirement. But selling their primary home may become more difficult if prospective homebuyers start sitting on the fence, waiting for prices to decline.
And even if prices don’t fall but simply stagnate, many heavily indebted homeowners will start struggling, as we previously reported.
For example, homeowners with only four to five per cent equity in their homes would likely lose money from selling their homes in an environment where housing prices are no longer climbing, Douglas Hoyes, a licensed insolvency trustee at Kitchener, Ont.-based Hoyes Michalos, previously told Global News.
That’s because the fees and costs related to the sale of the home would likely amount to more than four to five per cent of the value of the house.
Having too much debt tied up in one’s home is a leading cause of personal bankruptcy among Ontario homeowners, according to a recent report by Hoyes Michalos.
In 2016, nine in 10 insolvent homeowners had very little equity in their homes, with the average mortgage debt amounting to 85 per cent of net realizable value of their home (which is the sale price minus real estate agent fees, taxes and other costs).
Insolvencies are now at record lows through much of Canada, but that could change once interest rates start climbing.