Rising interest rates a warning to consumers on cost of high debt loads

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The Bank of Canada's second interest rate increase this summer has financial experts warning that more could be on the way, and now is the time for Canadians to take a serious look at their debt.

Patricia White, executive director at Credit Counselling Canada, says years of increased borrowing at low interest rates means many people aren't prepared for the higher costs that could be coming.

"Everyone needs to look at where they're at, because we suspect that the Bank of Canada governor is just going to continue to do this."

White says the growing use of home equity loans and lines of credit means more Canadians are exposed to immediate changes in borrowing rates, while those thinking about buying a home need to take a prudent look at what they can afford to pay.

"The point is people need to get their head out of the sand and take a look at things. We've had that nice lull over several years – now reality hits."

The warning comes as the central bank hiked its rate Wednesday by one-quarter point to 1.0 per cent, its second 25-basis-point increase since July and the first round of increases since 2010.

The rate increase means about $50 more a month for an average $480,000 home in Canada on a variable-rate mortgage, said Janine White, vice president of RateSupermarket.ca, while Toronto's higher average housing price of $670,000 means the increase would be about $80 a month.

"What you need to look at is the compounding of it," said White. "If you paid an extra $80 in July on your mortgage, and now you're paying another $80, and economists are thinking that this will go up again, it's about understanding what you can manage when you look out to the future."

She said those with fixed-rate mortgages won't be affected until their rate comes up for renewal, but they should start planning now for the potential shock of higher rates when they do.

Eric Kam, an associate professor of economics at Ryerson University, said the government is using the increase in interest rates to temper the housing market.

"It's the government saying, so many people have been investing in things that they may or may not sustain if rates go up. So let's let rates rise a little bit and let's see what of this is solid, and what drops to the wayside."

Kam says the rise in rates so far would likely not stop anyone from buying a home, but they may consider a smaller one.

"I think this is really in a sense an earbud on behalf of the government to put it into people's minds to say just be weary of your debt load."

Equifax released a report Tuesday that showed those debt loads have been persistently increasing, and at $22,595 per person in non-mortgage debt, are now at record highs.

Regina Malina, senior director of data and analytics at Equifax, said delinquencies and bankruptcies have been dropping despite the rising levels, showing that so far debt levels are sustainable.

She said that on a general level, the increase in rates so far could add $50 to $150 a month to a household, which is a slow enough change that most people will be able to adjust.

RBC CEO Dave McKay, speaking at a financial summit in Toronto Wednesday, however, said increased payments on mortgages and other debts could hit the economy as people have less disposable income to spend elsewhere.

"That's one of the effects that we don't talk enough about. As rates rise, as they did this morning, a greater amount of disposable income is coming out of purchasing power, which will slow down economic growth in other sectors. And that's not a healthy thing in the long term."

Bank revenues to climb

Canada's biggest banks are poised to benefit from Wednesday’s surprise interest rate hike, with Royal Bank of Canada's chief executive pegging the revenue bump at upwards of $300 million over five years.

RBC’s McKay told an industry conference in Toronto after the Bank of Canada announced the 25 basis point increase that the change should benefit the bank's retail franchise by roughly $100 million in revenue in the first year.

That figure could "increase to upwards of $300 million in year five as it takes a while to blend into the portfolio, as we roll off assets, and we refinance assets at the higher rate... For us, $300 million for 25 basis points is quite meaningful," he said.

The Bank of Canada's overnight lending rate hike to one per cent boosts Canadian banks' net interest margins, which is the difference between the money they earn on the loans they make and what they pay out to savers. That, in turn, translates into more revenue for the country's financial institutions.

The lending margins of Canada's biggest banks had been under pressure in recent years until July, when the Bank of Canada lifted its key interest rate from 0.5 to 0.75. That marked the central bank's first rate hike in seven years.

After July's rate hike, Canada's biggest banks quickly followed suit by increasing their prime lending rates by 25 basis points. Banks use the prime lending rate to set interest rates for variable-rate mortgages and other loans.

On Wednesday, RBC, Toronto-Dominion Bank (TSX:TD), Bank of Montreal (TSX:BMO), Canadian Imperial Bank of Commerce (TSX:CM) and Bank of Nova Scotia (TSX:BNS) moved to increase their prime lending rate by 25 basis points from 2.95 per cent to 3.2 per cent, effective Thursday.

TD CEO Bharat Masrani told the conference that rising interest rates are a "positive phenomenon" for the financial institution. In the U.S., where the bank has a large deposit base, the four rate hikes handed down by the Fed has been a "tailwind," he added.

Masrani was reluctant to put a dollar figure on the impact of a rate hike. However, he said it would be generally be positive for TD as long as the hikes are done in an orderly fashion and do not tip the economy into a major slowdown.

"If that were to happen on either side of the border it would not be positive ... The stage that we are at, and the cycle, I would think that for a while at least this would be a positive phenomenon," Masrani said.

CIBC's chief executive Victor Dodig told the summit on Wednesday that a 100 basis point increase, as a reference point, would translate to $157 million in after tax profit on an annualized basis across the board in the U.S. and Canada.