Should your spending change when interest rates rise?

Interest rates drastically affect your daily life. From investments to regular old purchases, interest rates, both on your personal loans and investments and the broader economic rate, can completely change how you interact with the world around you. It stands to reason, then, that you should be prepared to change your habits when interest rates rise as well.

Let’s take a look at a few of the things you should consider as interest rates begin to tick upward.

Why raise interest rates anyway?

Good question. You’d think that the Bank of Canada, which controls the interest rate on which all other rates are based, would like to keep things cheaper for Canadians. After all, if they raise their rates, things like loans get more expensive. That’s not terribly nice for the citizenry, right? Wrong! Low-interest-rate environments pump more money into an economy because money is cheaper by definition. When rates are low, folks tend to spend more money because it’s cheaper to do so, especially on credit, but also because they know that low rates won’t last forever. Why? Inflation.

When more money exists in the economy, it makes the power of each individual dollar slightly less powerful. This, in turn, makes things more expensive. We’ve seen over the course of the pandemic that, while wages have risen and unemployment has dropped, the cost of items has continued to increase. This is in part due to supply constraints but it has a heck of a lot to do with the amount of money floating out there in the economy. This is why the Bank of Canada wants to raise rates; raising them will restrict the amount of money in the economy, and bring the value of the currency back up.

You’re running a business

Look around you. Whether you’re renting or own your home, have a partner or not, kids or not, dog or cat, you are running your own personal business. Your home is your storefront. You work for a living and bring income into the business. You spend that income to improve your home and family and do things that you deem make your business successful, whether that’s vacation, new cars, or fun gaming systems.

It makes sense then, to run your household just like a business. When the economic environment around a business changes, that company needs to change how they do business or end up on the scrap heap. Perhaps a bit dramatic for your home, but the fact is, it's true. If you don’t take advantage and adapt when environments change, you’re going to have an exceptionally difficult time reaching your financial goals.

On that cheery note, there are a few things that you can do to help your household start to adapt to the coming rise in interest rates.

Family Financial Audit

Hopefully, you already have a robust budget. If not, now is the time to make one. Take a good hard look at the amount of money your household is bringing in and the amount you have to shell out each month. What fixed expenses do you have? Here we’re talking about things like rent or mortgage payments, your water, gas, and electricity bills, and any other critical items like medication or tuition. Next, take a look at your unfixed expenses. There might be slightly more of these than you think. For example, your grocery budget is an unfixed expense just like a Netflix or Peloton subscription. These aren’t things you need to have, in whole or in part. You can drop Netflix for a few months. You can cut grocery costs if you had to do so.

Next, take a good hard look at where you stand. This exercise may reveal that you actually have far less than you think you do. Maybe you’re outspending what you’re making every month. Hopefully, it helps identify some additional income you can use to take advantage of a few items before interest rates rise.

Lock in low interest rates now

Interest rates for large purchases typically come in two flavours: variable and fixed. We typically hear the term variable, or adjustable, in relation to mortgages but other loans could have variable rates as well. When you take out a variable-rate mortgage you’re agreeing to a certain rate for a period of time or as long as interest rates stay where they are. When interest rates rise, your mortgage interest rate can also rise. So, for example, if you take out a mortgage at a 2% interest rate and the prime rate offered by the Bank of Canada goes up by .5%, your mortgage payment will likely increase to 2.5%. This is an oversimplification but it illustrates the point. The increase doesn’t affect the amount you pay but affects the amount of your payment that goes to principal, as opposed to interest. The higher the variable rate, the more goes to interest, thus extending the life of your loan.

As you hopefully can tell by now, having a variable-rate mortgage or loan is not a great idea in an environment where interest rates are rising. Refinancing your mortgage into a fixed rate can help stem this increase. You may end up paying slightly more (to offset the money the bank won’t earn by the shifting rate) but you can count on your interest rate staying exactly the same for the term of your loan.

Buy now

If you’ve been holding off on making that larger purchase, whether it's a car, a home, or a brand new 4K television set, now is the time to buy. In fact, anything that you need to use credit to purchase should be purchased sooner rather than later. This is because closed-end loans like those that are used for purchasing cars and homes are generally locked in at the time they’re written. As interest rates rise, so will the rates lenders charge. A car purchased today at a .5% prime interest rate will be cheaper in the long run than one purchased when the prime rate is .75%.

You could end up paying quite a bit more for that car, home, or other large purchase just because you waited a bit too long.

Invest now

In low-interest-rate environments, folks look for stocks because they have extra money with which to purchase. As interest rates rise, people tend to move toward more stable investments, like the US dollar or gold. By buying those latter types of investments now, you can prepare for interest rates and values to rise. When investing, think of companies that collect when interest rates are higher, such as financial services companies. If you’re waiting to invest in real estate, now is the time as the cost of purchasing will go up dramatically.

Above all, budget

This really can’t be said any more strongly. In order to take advantage of rising interest rates, you need to have a strong idea of your financial position. Even if now is a good time to refinance your home or invest in commodities, you shouldn’t do so before ensuring these are decisions you can afford (with room to spare). With proper budgeting, you can take advantage of any type of market environment. It also doesn’t hurt to save a little extra for a rainy day… it could be coming.