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Interest Rates 101: The good, the bad, and the ugly


 

All good things must come to an end. In mid-July, the Bank of Canada raised its key interest rate to 0.75 per cent – the first hike in seven years. And many economists are predicting a second increase of a quarter of a percentage point in October.

The announcement immediately grabbed headlines – and the attention of Canadians, prompting many to question how an interest rate hike will impact their ability to pay down debts, and willingness to borrow money. But while rates affect everything from home mortgages to credit lines, there are steps you can take to safeguard your financial well-being as rates move upward.

First, it’s helpful to understand how interest rates work. An interest rate is the amount of money charged, as a percentage point, by a lender to a borrower for the use of an asset such as a car, a house or a business. The formula for figuring out simple interest is easy enough: If you were to borrow $1,000 at a 6% annual interest rate for 6 months, you would owe $30.

But not all interest rates are created equal. Here are a few ways interest rates can work for – and against you.

The Good:

Sometimes, the higher the interest rate, the greater the gain. Consider, for example, a savings account, where the bank pays you interest on your savings. In this case, rates tend to vary based on account type and term of investment. Fortunately, there are ways to maximize the amount of interest you earn on your savings:

  • Select a savings account with the highest interest you can find.
  • Find accounts with unlimited free transactions, no monthly fees, and surcharge-free access to ABMs.
  • Make sure the savings account doesn’t require you to maintain a minimum balance in order to earn interest.
  • Leave your money in the account for as long as possible.
  • Consider growing your interest in a Tax Free Savings Account, Registered Retirement Savings Plan, or Registered Retirement Income Fund account.

The Bad (and not-so-bad)

The Bank of Canada’s interest rate hike will impact homeowners with variable-rate mortgages. Homeowners with fixed-rate mortgages won’t be affected until their mortgage comes up for renewal. And Canadians with home equity lines of credit or other loans are also likely to see payments go up. Fortunately, there are resources available to help you manage your finances:

  • Enroll in an automated savings program.
  • A mortgage calculator can help you determine how the rate hike will impact payments.

The Ugly

Credit cards are known for carrying exorbitantly high interest rates. That’s because a credit card issuer charges the cardholder interest for the period of time in which the money remains borrowed if the balance is not paid by an established due date. Interest rates are set based on factors such as credit scores, but there are ways to eliminate or minimize interest charges:

  • Arrange a meeting with a knowledgeable financial advisor to prepare your finances for the future.
  • Pay off your credit card balance in full each month.
  • Make payments by the account’s payment due date.
  • Select a credit card with the lowest rate available.
  • Consolidate debt from higher interest cards to a lower interest credit card.
  • Evaluate repayment options such as a lower-interest loan that allows you to set a repayment schedule and carry lower interest charges.
  • Avoid making a credit card cash advance. In addition to transaction fees, cash advances charge interest immediately, regardless of the payment due date. And they’re known for having a higher interest rate than other transactions.
Interest rates may be on the rise but with the right tools and strategies, you can turn hikes into higher savings.

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