With interest rates on the rise, these precious personal finance rules are invalid

Low interest rates have ruled personal finance for more than a dozen years, and those who paid attention were big winners. But that chapter in Canada’s financial history is over. As in, finished. Toast. Finite.

To counteract inflation, interest rates are rising at an alarming rate. As a result, we need to rethink some personal finance rules that use low rates as the base assumption:

Investing is a better use of your money than paying debt

The Canadian stock market is up 30 percent overall in the last two years, while the interest rate on money borrowed on a mortgage or home equity line of credit was easily below 3.5 percent. If you had some extra money, using it to invest was by far the more rewarding option than paying down debt.

It was never a bad decision to pay off your loans – the results are guaranteed to benefit you with reduced interest and an accelerated timeline to become debt free. But investing was the choice that produced profits that he could wrap his hands around.

We had a great run for stocks, I hope you enjoyed it. In the coming months, expect extreme volatility fueled by hopes that post-pandemic economic renewal will take on inflation, rising interest rates and recession concerns. We have seen this type of market environment last Friday and Monday.

The risk of a poor investment outcome is rising, as are interest rates. The advantage of debt payment over investment grows day by day.

The only thing that matters is the monthly payment

Whether you’re buying homes or vehicles, most people’s preferred measure of affordability is the dollar amount of the monthly payment. When interest rates are stable, this approach works quite well. But as we’re seeing in 2022, payments can quickly become cumbersome.

Rates are rising with an urgency most borrowers have never seen or imagined. If you have variable-rate debt such as a line of credit, variable-rate loan or adjustable-rate mortgage, the cost of your loan is at risk of increasing on each Bank of Canada rate-setting date. The next date the bank could raise rates is July 13. After that, there are September 7, October 26, and December 7.

Protect yourself against rising debt payments by focusing on more than just how the monthly payment fits into your budget at the time of the loan. Two things to consider: How much is my income likely to grow over the term of my loan? And what percentage of household income does my total debt represent?

Mortgage lenders allow you to borrow up to the point where your combined payments on all debts are a maximum of 44 percent of your gross income. Try 35 percent and give yourself a break.

HELOCs are an easy way to borrow

One of the many attractive things about a home equity line of credit is that you can make a minimum interest-only payment each month. It gives you flexibility, right? Renew the kitchen today, pay the bill whenever you want.

A competitive HELOC rate is your lender’s prime rate plus a 0.5 percentage point markup. This year’s prime rate increases have pushed the cost of this HELOC up to 4.2 percent from 2.95 percent. Expected rate hikes in the next six months could push that rate up to nearly 6 percent.

On a HELOC balance of $50,000, an increase in rates from 2.95% to 6% would mean an additional $127 per month. That’s a big increase in spending for a household that already pays more for gas, groceries and more.

HELOCs still have a role for short-term loans, but they are rarer than they were a year ago.

Inflation means you lose money in savings and GIC

The inflation rate is 6.8 percent, while savings accounts offer between 1.5 and 2.4 percent at best and rates on guaranteed investment certificates exceed 4. 5 percent for five years. You can’t avoid a negative real rate of return if you deposit the money safely.

If someone mentions this to you, just ask where they are finding returns that outpace inflation these days. Stocks? The S&P/TSX Composite Index was down 3.3 percent in the year to June 10, and the S&P 500 was down 18 percent. Captivity? Down about 13 percent this year. Bitcoin? Down about 50 percent. A positive return on sure money that turns negative after accounting for inflation isn’t the worst thing these days.


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