WHATTODO ABOUT YOUR DEBT LOAD
Expert shares how you can take advantage of interest rate hike
Many consumers will soon find their debt loads heavier now that Canada’s central bank and the country’s biggest commercial lenders have raised their benchmark rates by one-quarter percentage point.
The country’s biggest banks raised their prime rates after the Bank of Canada hiked its overnight lending rate Wednesday by a quarter of a percentage point to 1.25 per cent. The Royal Bank of Canada was first to announce its prime rate will rise to 3.45 per cent. RBC was followed by Bank of Montreal, CIBC, Scotiabank, TD Canada Trust and Desjardins Group — a financial co-operative with offices throughout Quebec and parts of Ontario.
It’s a challenge for Canadians still struggling to cope with the record amounts of consumer debt they amassed after the 2008 financial crisis because lenders use their prime rate as a benchmark for setting some other short-term rates including variable-rate mortgages and lines of credit. A hike is good news for savers as the prime rate also affects interest rates for savings accounts.
If you’re contemplating how to best take advantage of the increased rates or avoid falling into further debt, personal finance expert and Ryerson University business professor Laleh Samarbakhsh shared her advice.
Q Now that the rate has gone up, what financial choices should I be making?
A With the interest rate increase, debt becomes more and more expensive. Before you do anything, you have to understand what kind of debt you have to start with.
We have good types of debt and bad types. Good types can include any investment that is made to contribute to progressing your future. For example, a student loan is a good type of loan because you are investing in your ability to make more money. At the same time, debt you have from real estate or your primary residence is considered a good type of debt because you’re accumulating equity.
Focus first on what is considered bad debt like credit card debt, lines of credit or any kind of debt with higher interest rates and no future investment. Pay off the debt with the higher interest rate first, but also consider what debt you have that is tax deductible.
Q If I have some money in a Tax-Free Savings Account, but also some debt, should I pull out that money in the account and pay off the debt?
A A lot of times people might consider borrowing from a lower debt to cover a higher debt or borrowing from a TFSA to make a payment. My recommendation is if you have some tax deductibility because of debt you have, keep it. As much as paying off debt is important, if you won’t be able to pay off all your debt, you can use the deductibility you have from some to save on taxes and create an income to pay off the high-interest or bad debt.
We have had a successful year on the investing market, so if an individual makes contributions to their TFSA and has a portfolio with a higher return of 20 per cent or 25 per cent, it makes sense to keep that because the advantage is no tax being paid in the TFSA.
Q What should I do if I have been looking at buying a home or if I just bought a home and am dealing with a mortgage?
A For individuals who care about their credit score and are applying for a mortgage shortly, consider your credit limit. The types of debt that have a credit limit should be paid off first to release your capacity.
The typical concerns after a hike are usually individuals with mortgages because those are the biggest debts people carry. My advice would be for individuals with variable mortgage rates to consider locking down a fixed mortgage rate.
Q What should I do if I have no debt, but want to take advantage of the hike?
A Saving is making even more sense now because savings accounts will have fairly higher interest rates, so if you have no debt, my recommendation is to start with capping your Registered Education Savings Plan contributions first because that brings you tax savings.
Once the RESPs are capped, I would also invest in a Tax-Free Savings Account. The interest you make is tax-free, so I recommend maximizing your TFSA contribution.