The ins and outs of interest rates

Interest rates have received a lot of attention in the news lately, especially as the Bank of Canada has hiked rates. This move is meant to curb inflation, but Canadians across the country are feeling the pinch. So what should you know about how interest rates work, and why they matter?

Who sets the rates?

The Bank of Canada is a Crown corporation tasked with overseeing the country’s monetary policy and economic stability, and it’s afforded a great deal of independence from the government. Recently, it’s made a series of rate increases, resulting in the highest rates we’ve seen in a long while.

This results in the country’s financial institutions borrowing and lending at close to the policy rate. If you’re a homeowner, it means that you’re likely paying a lot more for your mortgage than you expected to be. Variable rate home loans are more than double what they were just a year ago.

So how are these interest rates determined, and why aren’t they reflected in your savings account rates?

Interest can seem a bit complicated to the average Canadian. While it’s generally understood to be the cost levied in order to borrow an amount of money, which is called the principal, how the rate is determined is complex.

The primary things affecting interest rates include:

• Principal amount

• Length of term

• Repayment schedule

• Market factors

• Credit score

It’s these market factors that have had the biggest impact recently, with inflation causing the Bank of Canada to raise interest rates. That’s because it’s thought that higher rates will reduce overall demand for goods and prevent costs from continuing to increase, thereby curbing inflation. But the result is drastically higher costs to borrow money. 

Mortgage rates have seen a substantial increase, but even credit card interest rates are at a record high. And interestingly, these increased costs for borrowing money have significantly outpaced the interest rate returns most of us are seeing on our savings.

According to a recent CBC article, this gap can largely be blamed on a lack of competition in Canada. Canadians tend to be loyal to their bank. Instead of shopping around, which drives competition between banks, they usually remain with one bank and enjoy the additional services offered. While we’re often commended as a nation for the stability of our banking sector, it can also have a negative impact on us personally, which is what we’re seeing right now.

The same CBC article says that this gap between borrowing costs and interest rates on savings is larger than it’s ever been. So what should you do to minimize the impact on your own bottom line?

It can pay off to take a good look at how you’re borrowing and saving right now. Given the increased premiums on borrowing money, including for what is most Canadians’ biggest purchase ever – their home – it’s a good time to reevaluate what it’s costing you to borrow money.

Experts recommend shopping around, like at smaller banks or credit unions, to access slightly better rates. This addresses that crucial missing component in Canadian banking: vibrant competition.

It’s also a good time to reevaluate how you’re saving your money. Given the relatively lower returns banks are providing on savings accounts, it can be helpful to have an accountant review your overall savings plan. There may be better ways to invest your funds. Furthermore, reducing your tax burden can put more money back into your pocket and help ease the stress of higher interest and mortgage rates. But, don’t forget there is tax on interest income in Canada.

Make sure your finances are in order and your tax return is prepared by professionals who appreciate how the volatility of interest rates is affecting Canadians. At MMT, we understand how hard you work for your money, and that’s why our tax experts will work equally hard to minimize your tax burden and keep as much money in your pocket as we possibly can.

Outsourcing your accounting needs, whether you’re an individual or small business owner, can ensure you have the information you need to make smart financial decisions. The volatility of interest rates is only one of the ways your finances may be impacted. Contact MMT Chartered Professional Accountants today and find out how we can help you weather this storm and prepare for any in the future.

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