What are interest rates and who sets them?
Interest rates are the rates that financial institutions such as banks charge customers to borrow money. The Bank of Canada (BoC) is responsible for the country's money system, including setting interest rates.
The BoC sets two basic rates:
1 The bank rate is the rate at which Canadian banks can borrow money from the BoC for a single day. The BoC meets eight times per year to set the bank rate.
2 The overnight rate, also known as the policy interest rate, is the rate at which financial institutions borrow money from each other, and it’s the main driver of all other interest rates in the country. The BoC meets eight times per year to set the overnight rate.
Canadian businesses and consumers are affected by the overnight and bank rates, as they set the direction for all other interest rates, such as the ones you pay on mortgages, lines of credit, car loans, and credit cards.
With interest rates going up, 55% of Canadians worry about what that means for their personal finances.1
Why are interest rates going up?
Mostly because of inflation. As prices go up, it’s not only harder for you to manage your spending, it’s harder for businesses to manage theirs as well, so they may raise prices further, and so on, and all of this can cause trouble for the economy.
To slow down inflation, the BoC can step in to stabilize prices, and one of the tools it has is raising interest rates: When interest rates go up, fewer people and businesses borrow money, which means less demand for goods and services, which helps to lower prices.
Because inflation is rising so quickly these days, the BoC is aggressively raising interest rates. In April 2022, it raised the overnight rate to 1.00% and the bank rate to 1.25% and, much like the rest of the world, the bank indicated that there are likely more increases coming.
Although that change may not seem like much, it can have a big impact on your personal finances, both your debt and your savings.
Take mortgage payments as an example. Let’s say you have a $278,748 mortgage with a variable interest rate that’s currently 3.1%. That means you’re paying $1,411 per month, or $16,932 per year. A 0.5% increase in your interest rate has you paying $1,483 per month, or $17,796 per year; in other words, $864 more per year. If you have 20 years left on your mortgage, you’d pay an additional $17,280 over time, just because of a 0.5% increase in your interest rate. If rates go up more than that—as they’re expected to—the numbers get even worse.
How much your monthly mortgage payments will increase if interest rates rise2
Source: Government of Canada, 2022
Beware: variable interest rates and credit card debt
Any debt you carry will charge either a fixed or a variable interest rate. Fixed interest rates stay the same throughout the life of the loan, while variable interest rates generally change when the BoC raises rates. And when rates go up on your loan or credit card, you pay more to borrow that money. Some examples of variable rate loans include:
- Credit cards
- Home equity lines of credit
- Adjustable rate mortgages
- Other loans
Look at all the debt you carry. If any of your loans or credit cards have a variable interest rate, you might consider changing it to a fixed interest rate. You could do this by calling the issuer to see if you can change it to a fixed interest rate before rates go up again. Or you could consider shopping around for lower interest- or fixed interest-rate credit cards and loans or see if you can take advantage of offers to transfer credit card balances to a zero rate balance transfer card.
What else can you do?
There are a few more things you may want to consider if you'd like to try to minimize the impact of rising interest rates on your personal finances.
1 Look for places to cut your spending—Because prices are going up the same time as interest rates, find ways to live on less, such as:
- Buying generic instead of name brands at the grocery store
- Cutting back on expensive coffee drinks and eating out
- Staying home for family movie night instead of going out
- Taking a fun staycation instead of travelling somewhere
2 Pay with cash, not credit—Unless you pay your entire balance monthly, using a credit card and paying interest makes everything you buy more expensive.
3 Try to pay down your high-interest debt—Although you need to be sure you’re keeping up with all of your interest payments, see if you can make extra payments on your high-interest debt to pay it down sooner.
Knowing the basics can help you manage your finances
The economy and the state of your personal finances depend on lots of factors—and interest rates are an important one to understand. When you know how rising interest rates can affect your debt and spending, you’re better able to take action and minimize the impact to your financial well-being.
1 "More than half of Canadians concerned about impact of rising interest rates, up three points since September," MNP Consumer Debt Index, February 2022. 2 “Protecting yourself if interest rates rise,” Government of Canada, 2022.
The commentary in this publication is for general information only and should not be considered legal, financial, or tax advice to any party. Individuals should seek the advice of professionals to ensure that any action taken with respect to this information is appropriate to their specific situation.