Handling the hikes: 5 strategies for protecting yourself from rising interest rates
For the past two years, Canadians have enjoyed exceptionally low interest rates—with the Bank of Canada (BoC) overnight interest rate reaching as low as 0.25% at the start of 2022—making capital the cheapest it’s been in over a decade. Unfortunately, as it often goes, all good things must come to an end and since March 2022, the interest rate has increased six times to 3.75% (at the time of posting).
If you have a variable interest rate debt for you or your business, whether it be a mortgage, home equity line of credit or a certain type of credit card, you’re likely paying more interest on outstanding debt at a rapidly increasing pace. While piling debt may seem overwhelming, there are a few steps you can take to make it more tolerable and position yourself to succeed in the long-term:
Dealing with rising interest rates
It goes without saying that the best way to deal with rising interest rates is to pay down your debt as much as possible. The less debt you have, the less interest you’ll be paying and the more money you’ll have available to pay towards your principal. That being said, it’s not always easy to free up funds to pay down your debt when things are tight, and it’s hard to know which debt to start paying down once you do.
Here are some good starting points for protecting yourself from the impacts of rising interest rates:
1. Reduce your expenses
Likely the most obvious step to take, but not always the easiest to do, is looking for areas where you and your business can cut unnecessary spending. By bringing down your expenses and holding on discretionary expenditures, you’ll be able to save more money that can be put towards your debt. Additionally, by ‘trimming the fat’ in your budget, you’ll be in a better position to succeed once your debts are paid down and interest rates fall to a more reasonable level.
2. Pay down debts with the highest interest rates first
If you have multiple credit cards, loans or line of credits, they will likely have different interest rates. Paying off the one with the highest interest rate first is critical to minimizing the interest you’re paying and becoming debt-free sooner. That being said, it’s important to still ensure you’re making the minimum payments on all your debts to avoid possible fees and penalties, which can be severe.
3. Consolidate high interest debts into a loan with a lower interest rate
By consolidating your high interest rate debts to one with a lower interest rate, you’ll be able to bring down your interest payments and simplify your payment to one lender. Most banks offer debt consolidation loans or balance transfer credit cards that allow you to pay off multiple debts with a new loan or card that has a lower interest rate. This allows you to make one monthly payment that is affordable and easier to plan around compared to multiple unaffordable payments to several creditors.
Several non-profit organizations in Canada, such as the Credit Counselling Society and Credit Canada, offer guidance and resources on debt consolidation options that may be available to you.
4. Avoid taking on additional debt that you don’t need
If you can avoid taking on new debt, that’s interest you won’t need to pay—plain and simple. Try to push off discretionary spending or defer purchases where possible, and that will help you save interest payments in the long run.
A key strategy to avoid taking on too much debt is to have an emergency fund that can be used for unforeseen expenses. As much as everyone wants to have a crystal ball and predict the future, unexpected things can (and will) happen and you might need access to funds in a hurry. By having an emergency fund set aside, you’ll be able to pay off unexpected expenses without having to take on any additional debt, or at least a smaller and more manageable loan.
5. Be wary of the CRA prescribed interest rates
Similar to the banks, the CRA also adjusts their interest rates but on a quarterly basis. From October 1 to December 31, 2022, the CRA will be charging taxpayers 7% interest on overdue balances and refunding taxpayers 3% interest on overpaid amounts. Then from January 1 to March 31, 2023, the interest rates will rise again by 1%, bringing interest on overdue balances to 8% and refunds on overpaid amounts to 4%.
In order to avoid paying interest on your taxes (yes, taxes can get even worse) make sure you pay outstanding tax balances and remit the instalment payments when required to avoid the steep penalties.
If you’re facing a growing mountain of debts owed by yourself or your business, contact your DMCL advisor; they’ll be happy to offer advice that will help you weather the storm of rising interest rates and chart a course back to calmer waters.
Article written by Michael Fung, CPA