Here are some of the ways you can expect falling interest rates to affect you, from mortgages to savings to investments.
Why the Rate Drops?
The Bank of Canada’s benchmark rate—called the overnight rate—is the rate of interest financial institutions use to borrow money from each other for one day. In turn, this key rate influences the rates individual banks charge when they loan you money or pay out interest on your savings.
The BoC uses its overnight rate to regulate the economy. For example, when the economy slows down (as it is currently due to the coronavirus pandemic), the BoC lowers interest rates to encourage financial institutions to decrease interest rates on their loans and mortgages. This makes borrowing money cheaper for consumers and businesses who will go on to spend and invest those borrowed dollars, helping to boost economic activity.
What the Rate Drop Means For Your Savings
As mentioned above, financial institutions take their cues from Canada’s central bank, and many have already responded by lowering the interest rates offered on savings accounts. That means any money you’ve socked away in a bank account will earn less in interest income than before the rate drops.
How much less you earn depends entirely on the rates set by your individual bank. That underscores the importance of finding the best online bank and services to match your needs and financial situation. The BoC cut its rate by 50 basis points on March 4, then by another 50 basis points on March 13, and a further 50 basis points on March 27. In effect, this means you could see your savings account interest rate go down by up to 1.50%
If your savings are in GICs (guaranteed income certificates), you will continue to receive the rate of interest agreed to at the time you purchased them until their maturity date.
To make the most of your savings in a low-rate environment, compare the best high-interest savings accounts and GIC rates in Canada to see which financial institution has the most attractive offers. For example, EQ Bank currently offers a highly competitive rate of 2.20%* for a one-year GIC. When markets are extremely volatile like they are now, GICs are the best and safest options for saving money without stress over potential losses, thanks to guaranteed rates.
Meanwhile Tangerine is offering a five-month promotional interest rate of 2.80%* to clients who open their first Tangerine Savings Account (including TFSA, RSP, RIF and US$ Savings Accounts). Wealthsimple Cash also offers an everyday interest rate of 0.90%.
*Interest is calculated daily on the total closing balance and paid monthly. Rates are per annum and subject to change without notice.
How Do the Rate Drops Affect Your Mortgage
As with savings accounts, a number of financial institutions have lowered the prime rates on their mortgages in the wake of the Bank of Canada rate cuts. So, for example, if a lender’s prime rate was 3.95% before March 4, and it decided to follow suit with additional rate cuts 0f 1.5%, the prime rate now would be set as low as 2.45%.
If you have a variable rate mortgage, you will immediately benefit from a reduction in your lender’s prime rate in one of two ways:
- Your regular payment amount will decrease. While the amount you pay down on your mortgage loan principal each month (or a week, or at whatever frequency you make payments) won’t change, the interest charges will be lower thanks to the rate change. To put that into real terms, a 1.5% interest rate drop to 2.45% on a $500,000 mortgage paid monthly will save you about $390 per month in interest. And over the life of your mortgage, that could be as much as $117,000 less in interest charges.
- You could pay off your mortgage faster. If you choose to keep your payment amount the same as it was before the rate drop, the savings you enjoy from the lower interest rate will be put toward paying down more of the principal each month. Again, in real terms, a 1.5% interest rate drop to 2.45%, but keeping your payments the same as before, will shorten your amortization period by 57 months (or 4.75 years), assuming you were in year one of a 25-year amortization. You could save as much as $151,100 in interest over the life of your mortgage.
Unfortunately, if you have a fixed-rate mortgage, your monthly payments (or amortization) will not change. However, it’s worthwhile investigating whether you can renegotiate your mortgage contract—and pay whatever fees or penalties apply—to enjoy the lower rates (especially if rates go down even further). Obviously, this would only make sense if the savings from the lower rate is greater than the expense of breaking your current mortgage contract.
If you’re buying your first home or refinancing an existing mortgage, the low interest rates could really work in your favour. But don’t just take the first interest rate that you’re offered from a mortgage lender, and instead, shop around for the best rate possible. For instance, check out the best online mortgage lenders in Canada, as they often offer competitive rates that beat out the “Big Five” Canadian banks. Just do your homework!
What Does it Mean For Your Investments
Here is where things get tricky. During low-rate environments, businesses and consumers usually look to investments to obtain higher returns on their savings than bank interest provides.
But financial markets hate uncertainty, and you can’t get more uncertain than an unprecedented global pandemic that’s threatening both health and incomes. The markets have been understandably volatile in the past month with the value of Canadian stocks falling by about 30%, according to the S&P/TSX Composite Index.
While that may sound alarming, I’m not too worried. My RRSP portfolio is probably down considerably—I don’t know by exactly how much since I’ve decided not to check it—but since I’m not set to retire in the next decade and the markets will eventually rally, I’d rather not obsess over how much money I’ve lost on paper. Unless I panic and start selling off assets (don’t do this!), I won’t sit out the recovery and realize real losses. In the meantime, as long as my income remains stable, I’m continuing to make my usual monthly investment contributions.
Bottom line? A certain amount of volatility is baked into the market, and the best course of action is to stay invested for the long-term rather than lock-in investment losses by selling. For new investment purchases, go slowly and spread them out as monthly automated contributions. This will help you avoid the risks of trying to time the market since nobody knows when the recovery will begin.
If you do end up selling (non-registered) investments at a loss, it’s considered a capital loss that can be used to offset any capital gains you might have in the same year (and possibly for gains from previous and future years). These losses will lower your income taxes.
How to Maximize Investment Returns
No matter what interest rates or the markets are doing, there are three solid ways to maximize your returns:
Diversify your portfolio
That means choosing investments across a variety of sectors (e.g., retail, real estate, energy, tech, healthcare, financial services, utilities), different global markets (Canadian, US, international) and with a balance of asset types (equities, bonds, etc.). That way, if one sector, location or asset type performs poorly, other investments in your portfolio will hopefully offset those losses.
Lower your investment fees by using a discount brokerage or robo-advisor
If you are savvy enough to purchase your own investments online, choose one of Canada’s best discount brokerages, such as Questrade or Wealthsimple Trade, to get the lowest fees possible on ETFs, stocks and other assets. Now is a great time to sign up because Wealthsimple Trade is offering Young and Thrifty readers an exclusive deal: get a $10 cash bonus and $0 commission trades when you open a new Wealthsimple Trade account. All you have to do is deposit $100 and buy $100 worth of stock within the first 45 days.
If, on the other hand, you prefer to take a hands-off approach to investing, a robo-advisor like Wealthsimple will recommend a diversified portfolio of low-fee ETFs for you based on your answers to a few online questions regarding your age, comfort level with risk and investment goals. Plus, you can take advantage of our exclusive promo offer: open and fund a new Wealthsimple Invest account with $1000 within 45 days, and get a $75 cash bonus deposited into your account.
If you are thinking about building your own portfolio, get a full understanding of the types of investments available before making the leap to DIY investing. Check out these comprehensive pages – how to start investing in Canada guide and how to buy stocks.
Tax shelter your investment earnings by putting them in an RRSP or TFSA
Any investment income (including from GICs, stocks, bonds, mutual funds, index funds and ETFs) is taxable income, unless the investments are held within a registered account. But which should you choose: TFSA or RRSP? The main differences between registered accounts are how and when you are taxed on contributions and earnings.
With an RRSP, you get the benefit of a tax deduction for your contributions in the year you make them and your investments grow tax-free while inside the RRSP. But you must pay income tax in the year you start to withdraw funds. Your annual RRSP contribution limit is 18% of the previous year’s earned income, up to a maximum of $27,230 for 2020.
With a TFSA, there is no tax deduction when you contribute and your investments grow tax-free while inside the TFSA. The real benefit comes when you withdraw the money — completely tax-free. The current annual TFSA contribution limit is $6,000 (2020) and the cumulative maximum is $69,500 for those who were 18 or older in 2009 when TFSAs were first introduced. Just shop around for the best TFSA savings accounts before taking the plunge.
The Final Word
In general, lower interest rates are not great for savers, although there are still some savings products out there that pay 2% or more if you look hard enough.
Borrowers are the real winners when interest rates go down, especially those with a variable rate mortgage. They can save big time on their monthly payments, or choose to keep their payments the same and instead reduce their amortization period.
Investing in equities is generally the rule of thumb when interest rates are low but, because of market volatility due to COVID-19, you need to be comfortable with the possibility of seeing future losses before the recovery begins. In any environment, it’s best to choose a diversified, balanced, portfolio of low-fee investments and make the most of registered accounts (such as RRSPs and TFSAs) to save on income taxes.
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