There’s a lot of talk in the news lately about rising interest rates. If you’re carrying a variable-rate mortgage or have money out on a line of credit, this talk may have you concerned, and rightly so.
But, surprising as it might sound, there are a couple of ways in which rising interest rates can actually benefit your finances — if you know how to take advantage of them.
Why are interest rates going up right now?
To understand why the Bank of Canada and other financial institutions are starting to raise rates, it helps to first understand the effects of lower interest rates on the overall economy.
Canadians have enjoyed historically low interest rates in recent decades, which has been a boon for borrowers. Low interest rates make it cheaper to borrow money and often result in less urgency around saving. That’s because low interest rates mean lower returns on savings accounts or other savings vehicles, guaranteed investment certificates.
As Canadians borrow and spend, the economy grows. While economic growth is generally good, it can become unsustainable when demand outpaces supply, which is when inflation begins to rise beyond normal levels.
Sustained periods of high inflation typically prompt the Bank of Canada to raise its benchmark interest rate, and Canada’s other banks and financial institutions soon follow suit, which is why rates are going up right now.
Benefits of rising interest rates
1. Tamed inflation
In May 2022, the most recent data available, Canada’s annual inflation rate was at 7.7%, the highest since 1983. While it may be possible for people to scale back on non-essentials like streaming services or vacations, it’s harder to avoid spiking grocery and fuel prices.
One of the most significant benefits of rising interest rates is they tend to slow inflation. That’s because, when discouraged to borrow and encouraged to save, people typically begin to spend less money.
As people spend less, supply begins to exceed demand, which in turn causes prices to rise more slowly or even fall. In an effort to encourage people to buy more goods, producers and retailers tend to lower prices. As costs decrease, inflation slows or even reverses course.
2. Accelerated savings account growth
When interest rates are low, borrowing power increases, and the benefit of stashing money in a savings account decreases. When interest rates trend upward, it’s good news for savers, however.
As the Bank of Canada reduces its benchmark rate, slowly but surely, Canada’s major financial institutions usually respond by raising interest rates on accounts like high-interest savings accounts (HISAs) and tax-free savings accounts (TFSAs).
Better interest rates and the magic of compound interest accelerate savings growth, which in turn encourages more saving.
3. Better returns on fixed-rate investments
As interest rates rise, fixed-rate investments like guaranteed investment certificates, and provincial and federal bonds, typically start to offer more competitive returns. To encourage consumers to “lock in” their money for a set period of time, these financial instruments sometimes offer even higher interest rates than those offered by HISAs.
Because bonds and GICs a fixed rate of return, they are generally a solid option for Canadians looking to capitalize on higher interest rates with minimal risk. For those looking to maximize their savings, GIC laddering (a strategy in which you purchase several GICs with different terms) can also be a good approach.
4. A less-crowded real estate market
Another silver lining of rising interest rates is the potential cooling effect they’re likely to have on the housing market.
Much has been written about Canada’s competitive real estate market, which was spurred in no small part ty historically low rates. Lower mortgage interest rates made home loans easier to manage, and eager house hunters flooded the market. This demand encouraged sellers to increase their asking prices, making it harder for buyers to find an affordable property.
As interest rates begin to rise, mortgages will become more costly and less manageable. It will also become more difficult for potential homeowners to pass Canada’s mortgage stress test.
Increased costs and qualification requirements will cause some buyers to delay their plans to buy, which economists say should help stabilize the housing market. Fewer buyers will likely lead to less competition, which could make it easier for those with solid financing to find and purchase a home.