Will rising interest rates lead to more bankruptcies?Chantal Gingras
The policy interest rate increase posted by the Bank of Canada generated a lot of talk last month. Unsurprising, since it was the first increase in nearly seven years. For a few days, it seemed everyone was holding their breath!
Are Canadians in a strong enough position to absorb this increase? Will rising interest rates push people to declare bankruptcy?
Economists and financial experts have appeared in the media to discuss the expected consequences of the increase.
A month later, the dust has settled and everyone is breathing normally again. It’s time to review the impacts of the interest rate increase on consumers.
The impact of the interest rate increase is minimal but…
In the short term, most consumers have nothing to fear from the higher key interest rate.
First, financial institutions are free to set their own mortgage rates. Fluctuations in the Bank of Canada’s key interest rate certainly have an impact on the interest rates of other banks, but they are not automatically the same.
Second, the 0.25% increase is minimal. A bank could, for example, increase interest rates on an individual by the same percentage. This translates to additional monthly costs of about $30 on a $200,000 mortgage amortized over 25 years. Of course, only people with a variable rate mortgage will feel this slight increase immediately. People with a fixed-rate mortgage would not be affected until it’s time to renew. Even then, they would be able to take advantage of the fierce competition between financial institutions. This competition is what allows consumers to negotiate their rates and minimize the impact of the key rate increase.
So are the people sounding the alarms exaggerating when they advise people to be cautious?
No! There are indeed risks.
Are there more increases to follow?
Economists of large financial institutions across the country are all forecasting further increases from now up to 2019.
While last month’s increase was not steep, the next increase will be more noteworthy. The scale of the impact to be expected will depend on the key rate increase.
Paul-André Pinsonnault, senior economist at National Bank Financial , predicts that the key interest rate will reach 1.50% in 2018. Payments from our previous example–a $200,000 mortgage amortized over 25 years–would then cost $175 more per month. That is more than $2,000 per year.
It therefore makes perfect sense to expect that such an increase would have a severe impact on many families. This does not automatically mean that Canadians will necessarily declare bankruptcy, but many homeowners will have to revise their budget. Spending budgeted for things like “leisure” and “eating out” will have to be cut to be able to set aside the amount of money required to pay the mortgage.
But for those who are already in debt and for whom money is tight, these increases may be the final blow.
Lines of credit are also affected
Besides mortgages, other products such as lines of credit are also affected by rising interest rates. Excluding mortgages, lines of credit make up the largest amount of debt held by Canadian households (48%).
According to a report from the Financial Consumer Agency of Canada (FCAC) published in June, the average outstanding balance of these accounts is $70,000.
Therefore, people with this type of product should also expect additional costs due to fluctuating interest fees.
By adding these fees to the increase in mortgage payments, the final bill will be enormous for some people.
Are we trending towards an increase in bankruptcies?
Insolvency cases reached a record high in 2015. That number, however, is currently decreasing thanks to more favourable economic conditions and low unemployment rates.
The Bank of Canada policy rate increase is directly linked to the economy, which is currently strong and robust.
It is true that the increased interest rates will inevitably bring about financial problems for some households. That said, there are no indications that we should be anticipating a significant increase in the number of bankruptcies any time soon.
Surviving the interest rate increase
In the long term, virtually everyone feels the effects of increased interest rates to varying degrees. Some will be hit harder than others. To make sure you’re not one of them, don’t wait until you’re in the red to act.
Make a plan immediately.
- Use online mortgage calculators to develop potential scenarios
- Review your budget
- Create an emergency fund if you don’t have one yet
- Immediately cut any unnecessary expenses
- Change your more expensive habits right now
- Consult a Licensed Insolvency Trustee if you are unable to repay your debts