How will a hike or cut in the policy interest rate affect your budget?

What is the policy interest rate?

The policy interest rate, also known as the key interest rate or target for the overnight rate, is the interest rate set by central banks for a country or group of countries. In practical terms, this rate determines how much it will cost to borrow money from this institution.

Across Canada, the Bank of Canada is in charge of regulating the country’s economic activity, among other things. Once it sets the policy interest rate, financial institutions use it to set the interest rates on the variable-rate financing they offer their customers.

Inflation is an overall rise in the average price of goods and services. A low, stable and predictable inflation rate means the economy is doing well and the purchasing power of money is maintained. When inflation is high, consumers, businesses and investors lose their purchasing power, which hampers economic development. In this situation, the Bank of Canada usually intervenes by raising the policy interest rate to stabilize the Canadian economy. This intervention aims to reduce aggregate demand and control rising prices. 

→ Get a better understanding of the impact of inflation and market volatility on your savings

A cut in the policy interest rate: How will it affect your finances?

When the policy interest rate falls, so do prime rates on personal loans and lines of credit. If you’ve got a project in mind, like renovating your kitchen or buying a car, a rate cut could be a good time to make your plans a reality! 

→ Find out how to save for your projects

A hike in the policy interest rate: How can you protect your finances?

Should the policy interest rate rise, take the time to analyze your current and future projects. You can then make informed decisions, such as whether to go ahead with a project or postpone it for a few months to save more.

Here are a few strategies to counter the impact of rising rates and inflation on your finances:

If you find that food and gas prices have gone up in the past year, it’s a good time to update your budget and evaluate your projects and priorities.

→ Create a simple, balanced budget in just a few steps

→ Explore our series of money-saving tips

→ Draw up a grocery budget

If you’re planning to buy your first property, rising mortgage rates could alter your plans, affecting your borrowing capacity and your budget for the first few years.

→ Discover your borrowing capacity with a mortgage pre-approval

→ Learn more about first-time home buyer incentives and grants

If your mortgage is set to expire in less than six months, opting for an early renewal before the next rate hike could help you secure a lower rate without penalty. For mortgages with a longer maturity date, you’ll need to take penalty fees into consideration if renewing early. 

→ Prepare for your mortgage renewal in a few easy steps

→ Learn more about mortgage renewal before your term expires

As a general rule, if you have a variable-rate mortgage, your monthly payments will increase as interest rates rise. However, some institutions offer a variable rate with fixed payments, which means that your payments won’t change. Converting your variable-rate mortgage to a fixed-rate mortgage could be advantageous to stabilize your monthly payments before any further increases.

→ Make an informed decision when choosing your mortgage rate

If you have debts such as a line of credit, a personal loan or a credit card balance to repay, prioritize payment of those with the highest interest rates.

→ Read our advice on how to pay off your debts

If you have any concerns about your investments, discuss them with a financial advisor – it’s important not to make any hasty decisions. In long-term strategies, it’s perfectly normal for the value of certain investments to fluctuate. Remember, you don’t have to change your financial plan just because markets are volatile for a period of time or inflation and the policy interest rate are rising.

What are the effects on your mortgage?

If you have a variable-rate mortgage, the effect should be reflected in your next monthly review. You could even consider switching to a fixed rate to secure lower payments.

If you have a variable-rate line of credit, the effect on your monthly payments will be immediate.

If you have a fixed-rate mortgage, your payments won’t change until the time of renewal. 

Is your mortgage expiring in less than six months? Most lenders allow you to renew your mortgage up to six months before maturity without penalty. Some of them can also lock in a rate until the end of your mortgage term. You could take advantage of this to get a better rate sooner.

Before this six-month period, fees may apply. Take the time to compare these charges with the interest savings you could enjoy with a lower rate. Renewing your mortgage before the end of your term can be advantageous in certain cases.

And if you’re thinking of buying your first property, this could be the right time for you to make it happen. But make sure you have solid financial habits before committing to anything.

→ Discover the 7 steps to buying your first home