How To Immunize Yourself From Rising Interest Rates

Interest rates are going up and that’s putting a squeeze on anyone with debt. Whether it’s a mortgage, student loans, or a line of credit, you’re about to feel the sting of higher rates. We’ve had unprecedentedly low rates for almost 10 years now and forecasters have repeatedly called for higher rates, and it seems that they’re finally right.

The Bank of Canada just increased their rate again making this the 4th increase in the last 12 months. That increase means we’re being charged an extra 1% interest on variable rate debt versus last year. It also means any we’ll be charged an extra 1% on any new fixed rate debt. On a $350,000 mortgage that’s an extra $3,500 per year in interest charges or about $300 per month!

Rising interest rates impact all kinds of financial products. Variable rate mortgages, new fixed rate mortgages, lines of credit, home equity lines of credit and of course, student loans too.

Not only are we paying more for our current debt but rising interest rates also make it more difficult to qualify for a new debt too. Higher rates will decrease the amount of money you’re qualified to borrow. A household earning 80,000 per year will see their home buying budget decrease by $28,000.

There are a few strategies you can use to immunize yourself from the impact of higher rates, at least for a short period of time. From a few months, to a few years, to a decade, these strategies can help you avoid the sting of rising rates.

Warning: Making a financial decision based on interest rates alone is never a good idea. Often there are other factors to consider. Speak with your financial planner before making any major financial decision to ensure you’ve considered both the pro’s and the con’s of any strategy.

Pre-approved Mortgage

Getting a mortgage pre-approval is free and should be something every home buyer does before looking for a home. A pre-approval will help you figure out the maximum you can spend and how much your monthly mortgage payments might be.

More importantly though, a mortgage pre-approval will lock in your interest rate for a period of 90-160 days. Even if interest rates rise during that period you’ll be able to close on a home with the lower rate. This helps immunize you from short term interest rate increases.

Fixed Rate Mortgage

A fixed rate mortgage is exactly what sound like, it’s a mortgage with an interest rate that is set for the length of the mortgage. Mortgage terms are usually between 1 and 5 years, but you can get longer mortgage terms as well.

Locking into a fixed rate mortgage is usually more expensive than a variable rate mortgage. This extra cost is something that needs to be considered before locking into a fixed rate mortgage.

The benefit of a fixed rate mortgage is that you’ll be immune to rising interest rates for the length of the mortgage.

Get A Mortgage With Generous Pre-payment Privileges

If you’d prefer to get a variable rate mortgage instead of a fixed rate mortgage then at least look for one with generous pre-payment privileges.

Most mortgages have terms between 1 and 5 years. This makes it easier for banks to manage these massive amounts of money. Banks don’t want you to instantly pay off your mortgage because it causes them a lot of problems. As a result, many mortgages have strict pre-payment privileges. Often this is limited to 10-20% of the original principal each year.

Getting a mortgage with flexible pre-payment privileges can give you more flexibility to avoid higher interest rates in the future. If interest rates rise quickly you now have the option of eliminating a large portion of your mortgage each year to avoid those higher rates.

Make A Large Lump Sum On Renewal

When you renew your mortgage you’re not limited by pre-payment limits. Your mortgage renewal is a good opportunity to decrease your mortgage by a substantial amount at one time.

If you have a fixed rate mortgage you might be immune to higher rates for the length of the mortgage but as you reach renewal you become vulnerable to whatever rate is available at that moment.

I’m a big fan of having financial flexibility. Having options can help you avoid the impact if interest rates rise quickly. TFSA’s are a great way to gain financial flexibility.

TFSA’s are very flexible tax-free accounts. Large amounts can be pulled out of a TFSA any time. Investing within a TFSA gives you the option of pulling out your investments and paying off the mortgage if it makes sense to do so. This flexibly can be beneficial if rates rise quickly or if your financial situation changes.

Renegotiate Your Lines of Credit

Many lines of credits have interest rates linked to the prime rate, these rates are often negotiable. Negotiating the interest rate on your line of credit is a good practice for anyone who has improved their credit score recently.

By paying your debt on-time you can have a big impact on your credit score. As you improve your finances you can also benefit from a lower interest rate, but only if you renegotiate.

If negotiating with your bank feels awkward then try shopping around. See if another bank is willing to offer a better rate.

Pay Off Debt Faster

Obviously easier said than done, but a fool proof way to avoid the impact of higher interest rates is to pay off all your debt as fast as possible. Paying off variable rate debt as quick as you can is the best way to avoid the sting of higher interest rates. Here are a couple of ideas to help you pay off your debt faster.

Earning extra money to pay off your debt faster…

• Ask for a raise
• Create a basement suite and rent it out
• Rent your home on AirBnB while away on vacation
• Second job or side hustle
• Sell your extra stuff

Reduce expenses to pay off your debt faster…

• Start tracking your expenses
• Create a budget
• Get creative with your housing costs
• Reduce your grocery bills
• Find some ‘crazy’ ways to save