September 2023 LifeSpring Insights

If you’ve been nervously anticipating every rate announcement from the Bank of Canada over the last year and a half, you’re not alone. Changes to the bank’s policy rate affect everyone who has a mortgage or other debt. The bank’s rates also play a role in investment returns.

The good news for borrowers is that in its September 6 announcement, the bank held off on another hike. But inflation, as measured year over year in the consumer price index (CPI), rose 3.3% in July, well above the bank’s 2% target. That, plus, a strong August jobs report, mean the cycle may not be over.

Those with variable-rate loans have felt the hikes’ effects firsthand, as their interest rates rise with the bank’s policy rate, some also have their payments increase automatically. (Variables with fixed payments are a bit different – more on those below.) Borrowers with fixed-rate mortgages have been sheltered, but only for now: higher payments are very likely come renewal time. 

The main beneficiaries of the new rate regime are undoubtedly savers, who are enjoying interest rates on term deposits – similar to guaranteed investment certificates (GICs) – that are higher than they’ve been in many years – and well outpacing inflation. 

Before going further, if you are looking for sound advice for keeping on track with your financial goals, it’s best to make an appointment with your financial advisor as soon as possible. They can show you some potential future rate scenarios and help you build a financial plan that fits your situation, goals and risk tolerance – and can be adjusted as conditions change.

Meantime, here are some strategies to keep in mind as we adapt to higher rates, starting with mortgages, moving on to investments and, finally, covering a couple of possible moves for retirees (or near-retirees).

Mortgages: Game out future cash flow – and consider a shorter term at renewal

Variable-rate mortgage holders, as mentioned, have taken the brunt of rate hikes. But a certain type of variable-rate mortgage – those that offer fixed payments – is worth paying particular attention to. These mortgages account for three-quarters of all variable-rate mortgages out there, according to a November 2022 report from the Bank of Canada.

As the name says, a fixed-payment variable keeps the payment static, with more going to interest and less to principal as rates rise. In recent months, many people with these kinds of mortgages have passed their “trigger rate,” in which their payment no longer covers the principal. When that happens, unless the borrower makes a lump-sum payment to the principal or increases their payments, the mortgage loan balance is no longer going down and in some cases growing which is known as negative amortization.

Upon renewal, it’s likely these loans will need to return to their original amortization schedule, so these borrowers may be in a position where they have to make a lump-sum payment and/or increase the size of their regular payment. One strategy could be to make fixed, predictable lump sum “anniversary payment,” say at year end, until renewal, to spread the cost out. 

If you’re in this situation and concerned about the strain this could put on your finances, speak with your lender. You can convert your variable-rate mortgage to a fixed rate at any time, and you may be able to do so at a shorter term than five years – say two or three. 

That does lock in your payment at what may be the peak for rates, but rates on two- and three-year closed mortgages are near those of 5-year variable-rate closed mortgages today, so you may not pay much more in return for predictable payments. And with rates forecasted to move lower later next year, you may be able to renew your shorter-term fixed-rate mortgage with a lower payment.

If you’re on a fixed rate and are slated to renew in the next two to three years, your rate could jump substantially, given the difference between today’s rates and those of five years ago. This gap will widen as we move to 2025 and 2026, when mortgages that were initiated or renewed during the ultra-low rates of the pandemic come up for renewal. 

Here again, it’s best to meet with an advisor and game out potential scenarios, seeing where you might increase your income or reduce spending to better manage the higher payments. Then, as renewal draws nearer and you get a better sense of your rate, you can decide whether to opt for another five-year term or go with a shorter term or a variable rate, depending on the rate picture at that time.

Finally, you may have the option to extend your amortization at renewal, to help manage the payments, but you’d need to speak with your lender to see if this option is available.

Investments: Consider term deposits for shorter-term goals

Let’s move from mortgages to investments, specifically term deposits, which are paying historically high rates today. That makes them good options for short-term savings goals, as they typically run from 30 days to five years. 

To maximize your term deposits, consider holding them in a tax-free savings account (TFSA). That way, you can withdraw the interest you earn on your term deposit tax-free.

One interesting fact about a term deposit with a credit union like BlueShore Financial is that there is absolutely no risk to the principal you put on deposit. As a BCFSA authorized credit union, all deposits with BlueShore are fully protected by the Credit Union Deposit Insurance Corporation of British Columbia (CUDIC)** – meaning that you receive 100% deposit protection. Learn more about the accounts and deposits protected by this guarantee. 

Retirees: Delaying CPP could boost your cash flow

Finally, if you’re nearing the age of 60, you’ll have a decision to make: should you take your Canada Pension Plan (CPP) payouts at that time or defer? Most people take CPP at 65 or older, but you can take it as early as 60.

The benefit of putting it off is that that doing so boosts your payout substantially: if you start before age 65, for example, your payment actually shrinks by 0.6%, or about 7.2% a year, to a maximum of 36%.

Holding off till after 65 increases the payout by 0.7% each month, or 8.4% a year, till you turn 70, the maximum age at which you can defer. That’s much higher than current inflation rates of around 3.3% – and once you start drawing CPP, it rises by the inflation rate every year. Old Age Security works in a similar way, with the payout growing 0.6% for every month you defer starting payouts past the first month after your 65th birthday, to a maximum of 36% if you wait until you turn 70.

Finally, if you haven’t considered annuities as a source of retirement income, now could be a good time to do (under an annuity, you invest a certain amount and receive a regular income stream in return). Until recently, annuity rates have been low, but they’ve risen with interest rates. Speak to your advisor to find out if annuities may be right for you.

Stay on track with your financial goals

Whether you’re navigating today’s rates for financing your home or financing your retirement income, a professional financial advisor can help make sure you are staying on track with your goals. They can also help update your financial plan, review your mortgage and investment options, or simply provide advice, answers and solutions for making your way through this high-rate environment. Make an appointment with your advisor today.