How your interest rate affects your debt payoff
Although interest rates hovered at record lows for well over a decade, within the last few months, interest rates have increased twice. Analysts believe that there are more interest rate hikes to come at some point in the near future.
“It’s important to remember that all of your debt payments and your budget will be impacted by interest rates going up and down. The focus tends to be on mortgage payments when interest rates go up and down, but all of your credit products, including your credit cards and lines of credit will be impacted to varying degrees,” says Jeff Schwartz, Executive Director, Consolidated Credit Counseling Services of Canada.
“To simplify, your household income gets less mileage with your debt payments when rates go up. Your debt payments actually cost you more. Furthermore, it takes even more money to try to pay the principal of your debt down,” says Schwartz.
Unless your income goes up in parallel to interest rates (which doesn’t generally happen) then you’ve got a few problems to deal with: your timeline to pay down your debt gets extended, which means that you’re untimely going to pay more in interest; your household budget will get stretched even further as you try to service that debt, which is tough if you’re already pretty tight, to begin with.
If your goal has been to pay down debt, you’ve got to be cognizant of the interest rate environment that we’re in and how you need to adjust your budgeting and debt repayment.
If you haven’t already, it is time to stop spending money on your credit cards. Every dollar you add to your debt pile is only going to accrue more interest (now at a higher rate) and keep you further from your debt payoff plans.
Switch to cash only and make a point of spending within your means.
More than the minimum
You may already be aware of how little only making minimum payments does in actually reducing your debt load. With interest rates going up, it is essential that you commit to paying more than the minimum in order to reduce your debt load and get momentum with your debt payoff.
Don’t trap yourself
It can seem tempting to forgo savings if your budget is extra tight now with the hike in interest rates. That’s a bad idea. Although your focus is paying down debt, you need some cash on hand for savings.
As a small silver lining in these interest rate hikes, savings accounts interest rates will go up marginally, so you’ll earn a tiny bit more in your savings account.
Get rid of higher interest-bearing debt
Certainly, high-interest debt is going to be most impacted by the rise in interest rates and will be even more impacted if rates go up again. To avoid being vulnerable to these rises, reduce your debt load as much as possible (and as quickly as possible) by getting rid of your high-interest debt first.
If you know that your mortgage is coming up for renewal, now is the time to shop around to get the best interest rate that you can (lenders give rate guarantees for up to 120 days, usually). Also, take advantage of this opportunity at the renewal of your mortgage to put a lump sum down if you are able. That reduces your debt load, reducing the gap between what you own and what you owe of your home, which protects you more from interest rate fluctuations.