Recent headlines may have you worried about changing interest rates and what they mean for you. Understanding how interest rates impact your finances can help you make better decisions and feel more control over your financial future. Let’s go over the basics of interest rates.
What is an interest rate
Think of an interest rate as the cost of getting money to use now, in exchange for a promise to pay it back later. When you borrow money from a bank, you pay interest on it, in addition to repaying the money you borrowed. When you deposit money in an interest-bearing account (like savings or an investment), you earn interest on it because you are essentially lending money to a bank.
Interest rates can be impacted by a number of things, including the Bank of Canada rate, government programs, economic conditions, and the market. As a result, they can go up and down, changing how much interest you’re paying or earning.
Paying interest
When you borrow money, the interest you pay is a percentage of the total amount you have borrowed (also known as the principal). Each month, the interest is applied to the amount you still owe. So, the faster you pay off the amount you have borrowed, the less you will pay in interest.
To determine your interest rate, a borrower will also assess your ability to pay the money back. Generally, interest is higher for people with a low credit score or spotty credit history.
Earning interest
When you deposit money in an interest-bearing account, you earn interest in the form of a percentage of your account balance. Similarly, if you invest in a fixed-income product like a GIC, you will earn interest as a percentage of your investment.
GICs usually pay interest annually or at maturity, though some pay it on a more frequent schedule. Usually, interest is added to the balance of the GIC so it can compound and keep earning more. The higher your interest rate, the more your savings will grow.
How and why do interest rates change?
When you hear that interest rates have changed, it’s likely the Bank of Canada has changed its overnight rate – the rate at which banks can lend funds to each other at the end of the day. This change has a domino affect on the rates offered by all financial institutions, which allows the Bank of Canada to influence the economy. For example, if inflation is rising too quickly, the Bank of Canada will likely raise its interest rate to encourage people to save money, rather than borrow or spend it.
The Bank of Canada lowers its rate when the economy needs a boost. Lower interest rates help keep the economy moving by encouraging businesses and individuals to borrow and spend money.
How changing interest rates affect you
In an uncertain economy, interest rates are often on the move. A recent spike in inflation – something every Canadian has felt from the grocery store to the gas pump – has forced interest rates higher. How will this impact your money and your assets?
Mortgage rates
When the Bank of Canada raises its rate, mortgage rates usually follow. As lenders alter their rates, they balance risk with growth. Even for Meridian, where profit benefits Members instead of shareholders, we work hard to help stabilize the economy in times of change and help our Members thrive through uncertainty.
At Meridian, if you have a variable rate mortgage, your monthly payment will remain the same, even when interest rates rise. The difference will lie in the balance of interest and principal you pay each month. A rate increase means you’ll pay more interest and less principal, but you’ll have the stability of a consistent monthly payment.
If you have a fixed rate mortgage, however, neither your monthly payment, nor the amount of interest you pay each month, will change until you renew your mortgage, at the end of its term.
Savings accounts
As interest rates rise, you will likely see higher rates offered through your savings accounts. As a result, each month you will earn more interest on the balances you hold. No matter what the current interest rates, savings accounts are a low-risk way to set aside money and earn some interest.
Guaranteed Investment Certificates (GICs)
If you have savings you can set aside for period of time, a Meridian GIC is a secure tool to help you earn even more interest. Part of a balanced portfolio, GICs allow you to compound interest, making more money over time.
For example, if you purchase a 5-year GIC at 4.70%, you will earn 4.70% for each of the 5 years. You can ask for the interest to be paid out annually in cash or have it added back to the principal – rolled back into your investment – to compound and grow over the 5-year term.
Meridian offers a wide range of GIC options, including Fixed Rate GICs, market-linked GICs and our Raise the Rate GIC, which allows you to increase the rate of your GIC before your term is up.
Other investments
Over the last several years, the markets have experienced steep ups and downs, in reaction to global events and economic news.
While market changes can be unsettling, they are to be expected in any investment portfolio. Unless your goals or timeline have changed significantly, it is important to stick with your overall strategy. Trying to time the markets or chase a trend can result in frustration and expense.
If recent headlines have you wondering if your portfolio is still on track, bring your questions to a Meridian advisor.
Loans or refinancing
With interest rates on the move, you may be wondering if you should lock-in an interest rate on a loan, before rates climb further.
At Meridian, we understand that every situation is different. Speak to a Meridian advisor to secure a loan that suits your needs.
