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Interest rate increase: What it means for physicians

A young person sitting on a couch holding a mug, while using a laptop.

As the Bank of Canada and other central banks around the world continue to raise interest rates in efforts to rein in inflation, borrowing has become considerably more expensive. 

Following the Bank of Canada’s direction, Canada’s six big banks followed suit and raised their prime lending rate. Many borrowing products, such as lines of credit and variable-rate mortgages, are based on the bank’s prime lending rate.

Interest rates are one tool the Bank of Canada can use to influence the economy. The Bank’s goal is to maximize employment and maintain a healthy inflation target of 2%. By increasing interest rates, the Bank can slow down borrowing and thus slow down spending, in an effort to keep inflation in check.

As inflation remains high in this period of economic recovery and growth, the Bank of Canada says that it expects interest rates will need to rise further.

Let’s see how this may affect you.

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Federal student loans for med school and residency

Lines of credit

Mortgages

Canada Emergency Business Account (CEBA) loans

Investments

Federal student loans for med school and residency

Normally, higher interest rates would affect any student loans you are working to pay back. But at the height of the pandemic in April 2021, the federal government announced that no interest will accrue until March 31, 2023, on the federal portion of Canada Student Loans. So if you have a Canada Student Loan, you are not affected by the interest rate hike for now.

Lines of credit

If you have a line of credit, you will feel some impact. For instance, if you’ve used $100,000 from your line of credit and you were paying the 2.45% prime rate at the beginning of 2022, your interest cost per month was $204.17. At today’s rate of 5.45%, your monthly cost will have gone up to $454.17.

Effect of rising rates on monthly interest payments

A bar chart showing the additional monthly amounts given interest rates of 2.45%, 2.70% and 2.95% on mortgages of $50K, $100K and $150K

[Show me the text version: A]

We should, however, keep these increases in perspective. Many people have been able to take advantage of historically low interest rates over the past two years. The prime rate right before the pandemic began in March 2020 was 3.95%.

If you need to max out your line of credit, rising interest rates will impact you in another way: Interest rate increases effectively reduce the amount that you can borrow. That’s because your overall limit, including interest owing, does not increase. Furthermore, if you need to skip payments and add the interest owing to your outstanding balance — this is called “capitalizing” interest and is allowed on some student lines of credit — higher interest rates will further erode your available borrowing limit.

If you’re in medical school or residency, you might want to do some calculations to prepare yourself for rising interest rates. Start by figuring out how much more of your line of credit you’ll need to use, based on the number of years of medical school and residency you have left. While it’s difficult to predict how many rate increases are ahead, you could roughly estimate how much the additional cost will be.

If you’re concerned about your debt payments and wondering which debts to pay off first, your MD Advisor* can help.

Mortgages

Fixed-rate mortgage

If you have a fixed-rate mortgage, interest rate increases have no impact until your mortgage comes up for renewal.

Variable-rate mortgage

If you have a variable-rate mortgage, there will be an impact. Depending on your mortgage agreement, you will either see your payments increase, likely within days or weeks of the interest rate increase; or your payments will stay the same, but the amount that goes toward your principal will be reduced, reflecting the fact that you are paying more interest.

Keep in mind, though, that even with several Bank of Canada interest rate hikes, variable rates will still be below rates for fixed-rate mortgages.

If your payments will be increasing, you should do some calculations and budget for the monthly increase. The table/chart below illustrates some examples.

Effect of rising rates on monthly mortgage payments

A bar chart showing the additional monthly amounts given interest rates of 2.00%, 2.25% and 2.50% on mortgages of $700K, $800K and $900K

Source: Scotia Mortgage Calculator; amortization of 25 years

[Show me the text version: B]

If you have questions about your mortgage, talk to your mortgage specialist. They can help you assess whether it might be worth switching to a fixed-rate mortgage or whether you’re better off staying with a variable rate. The choice will depend on your personal circumstances and any penalties you would have to pay to switch.

First-time buyers

If you’re a first-time buyer in the market for a home, a rise in interest rates will reduce how much you can afford. More of your money will be going toward interest and less toward the principal, which means it will take more time to pay off your mortgage or your payments will be higher.

Canada Emergency Business Account loans

If you received a Canada Emergency Business Account (CEBA) loan, there is no impact from the interest rate increase. Created as pandemic relief, CEBA loans are interest-free until December 31, 2023. After that, if you still have a balance outstanding, it is converted into a two-year term loan with a 5% interest rate. The full amount of this loan (principal and interest) is payable on December 31, 2025.

Note: If you have a CEBA loan, be aware that the repayment deadline to qualify for partial loan forgiveness has been extended to December 21, 2023.

Investments

The markets, and your investment portfolio, can certainly be affected by rising interest rates in the short term. For example, rising rates can mean slightly more income from some fixed-income investments like new bonds and GICs. On the other hand, the value of some stocks may fall with rising interest rates, as companies pay more to borrow and their profits shrink.

The bottom line, however, is that other factors are more important to the success of your investments than interest rates. Your portfolio decisions should be based on your short- and long-term goals, risk tolerance and investment time horizon.

Your MD Advisor can help you adjust your asset allocation, guide you on suitable investments, and set expectations for the rate of return.

Read more about the Bank of Canada's interest rate increase to find out how MD is positioning its portfolios.

* MD Advisor refers to an MD Management Limited Financial Consultant or Investment Advisor (in Quebec), or an MD Private Investment Counsel Portfolio Manager.

The above information should not be construed as offering specific financial, investment, foreign or domestic taxation, legal, accounting or similar professional advice, nor is it intended to replace the advice of independent tax, accounting or legal professionals.

TEXT VERSIONS 

A. Effect of rising rates on monthly interest payments

Amount borrowed on line of credit

3.7% interest

4.7% interest

5% interest

$50,000

$154.17

$195.83

$208.33

$100,000

$308.33

$391.67

$416.67

$150,000

$462.50

$587.50

$625

[Back to Illustration: A]

B. Effect of rising rates on monthly mortgage payments

Mortgage amount

Monthly payment 2.50% variable

Monthly payment 2.75% variable

Monthly payment 3% variable

$700,000

$3,136

$3,224

$3,313

$800,000

$3,584

$3,684

$3,786

$900,000

$4,032

$4,145

$4,259

[Back to Illustration: B]