Managing your money when interest rates rise
When a rise in interest rates may affect you
A rise in interest rates often means that it will cost you more to borrow money.
A rise in interest rates may affect you if:
- you have a mortgage, a line of credit or other loans with variable interest rates
- you’ll need to renew a fixed interest rate mortgage or loan
Your financial institution could also increase your interest rate if you don't make payments on your credit card or loan.
How interest rates work
Interest rates rise and fall over time. If you’re borrowing money, interest is the amount you pay to your lender to use the money. The interest rate is used to calculate how much you need to pay to borrow money.
Financial institutions set the interest rate for your loan. This could be a mortgage, line of credit or another type of loan.
You can find your interest rate in your loan agreement. Your financial institution must provide you with certain information about interest rates on your loan.
Fixed and variable interest rate loans
When you get a loan, your financial institution may offer you a fixed or a variable interest rate.
A fixed interest rate will stay the same for the term of your loan. A variable interest rate may increase or decrease over the term of your loan.
Some lenders may offer you a lower introductory rate for a set period for certain types of loans. Make sure you can still afford the payments at the regular (higher) interest rate.
Dealing with a rise in interest rates
Pay down your debt as much as possible to deal with a rise in interest rates. If you have less debt, you may be able to pay it off more quickly. This can help you avoid the financial stress caused by higher interest rates and bigger loan payments.
You can deal with a rise by using these tips:
- reduce expenses so you have more money to pay down your debt
- pay down the debt with the highest interest rate first to pay less interest over the term of your loan
- consolidate high interest debts, such as credit cards, into a loan with a lower interest rate
- avoid getting the maximum mortgage or line of credit that a lender offers you
- avoid taking on unnecessary debt with things you want but don’t need
- avoid borrowing more money as it could limit your ability to save for your goals
- find ways to increase your income to help you pay down debt
- make sure you have an emergency fund to deal with unexpected expenses, such as covering higher loan payments to avoid penalties
What is a trigger rate
When your mortgage or loan has a variable interest rate with a fixed payment, you may reach your trigger rate if interest rises.
Your trigger rate is the rate at which your mortgage or loan payment will no longer cover principal and interest due for that period. Once you've reached the trigger rate, your payment will only cover interest payments and no money will go towards paying down your principal.
Reaching your trigger rate means that you’ve stopped paying down your loan and you’re now borrowing more money. This is often called negative amortization.
The best way to find out your trigger rate is to review your mortgage or loan agreement. You can also contact your financial institution. They’ll be able to calculate the exact rate for you. They’ll also be able to let you know your options if you reach your trigger rate.
If you reach your trigger rate, you may be required to:
- increase your payments
- make additional payments to cover the excess interest
- change to a fixed-rate mortgage
If you’re not at the maximum amortization period allowed, your financial institution may offer to extend your amortization. This would avoid having to increase your payments. However, extending your amortization means paying for a longer period and paying more interest in the long run.
Suppose you have a mortgage of $300,000 with a variable interest rate of 4% and 20 years left on your amortization. If you extend your amortization by 2 years, it’ll cost you $15,126.26 more in interest. The decision to keep the same payments while interest rates rise can become very expensive over time.
When interest rates are on the rise, contact your financial institution as soon as possible to find out about your trigger rate and to discuss your options.
Impact of a higher interest rate on your loan payments
The following examples show you how your mortgage, line of credit or loan payments may be affected when interest rates rise.
How a rise in interest rates could affect your monthly mortgage payments
Suppose you have a mortgage of $300,000 with a variable interest rate and a 25-year amortization. Your interest rate is currently 3% and it goes up to 4,5%. Your mortgage payment will go from $1,420 to $1,660. An increase of $240 a month.
Figure 1: Example of monthly payments for a mortgage of $300,000 with an amortization of 25 years at various interest rates
Text version: Figure 1
How a rise in interest rates could affect your personal loan monthly payments
Suppose you have a personal loan of $10,000 with a variable interest rate and a 2-year term. Your interest rate is 14.99%.
Your loan payment will increase by $24 a month if interest rates rise by 5%. That adds up to $552 more in interest over the 2 years.
Figure 2: Example of monthly payments for a personal loan of $10,000 with a 2-year term at various interest rates
Text version: Figure 2
When a rise in interest rates could affect your credit card or line of credit payments
There are times when fixed interest rates on credit cards or on lines of credit could also rise.
For example, if you don’t make your minimum monthly payments by the due date, the financial institution may increase your interest rate. In the case of credit cards, the rate will usually increase by 5%, but the increase can be higher.
Short-term promotional financing or deferred interest offers may be another reason that your fixed interest rate may increase. Make sure you know how long an offer lasts so you’re not surprised by the increase in your minimum monthly payments once it ends.
Banks and other federally regulated financial institutions must notify you before an interest rate increase takes effect.
Reviewing your budget with your new debt payments
If interest rates rise and your debt payments increase, you may need to review and adjust your budget.
To prepare yourself, try the following:
- talk to your lenders to find out by how much your payments will increase
- look at how the higher payments will impact your budget and your ability to save for your goals
- if you’re out of your comfort zone, see how you can reduce expenses or earn more money to pay off your debt faster
If after reviewing your budget if you expect challenges in making your payments, be proactive and don’t wait to seek help. Talk to talk to your financial institution to discuss your options. They may be able to offer temporary accommodations such as making special payment arrangements, mortgage deferrals or allowing you to skip a payment on your loan.
You may also want to talk to a credit counsellor to explore the different solutions that are available to you.
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