New Year’s debt

Opinion

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This article was published 06/01/2023 (717 days ago), so information in it may no longer be current.

A new year offers a fresh start that may be especially helpful for those increasingly feeling the weight of higher interest rates.

The cost of carrying debt by last year’s end had increased several times from what most people were paying at the start of 2022 with the Bank of Canada hiking rates 400 basis points from 0.25 per cent at the start of last March to 4.25 per cent by December’s end.

In turn, many of the millions of Canadians with variable interest rate mortgages are feeling the pain of these hikes now more than ever.

As well, about one in four also have home equity lines of credit (HELOCs) with variable interest rates, and nearly three in five are carrying a debt on those lines, according to a Ratesdotca study from last year.

“It’s just not a nice time to be a consumer carrying debt,” says Sandra Fry, debt counsellor with Credit Counselling Society in Winnipeg.

Fry says she has recently seen an increase in clients struggling with HELOC payments, albeit somewhat indirectly.

“We’re busier because nobody wants to use their lines of credit anymore” to deal with overspending as they often had in the past when interest rates were low, she adds.

Many homeowners, for example, with debt on HELOCs, which charge interest at prime plus 0.5 per cent or one per cent, are now paying significant interest-only charges with the prime rate at 6.45 per cent. That’s compared with 2022’s start when the prime rate was 2.7 per cent.

Licensed insolvency trustee Michelle K. Statz with Bromwich + Smith in Regina says many consumers she has worked with are seeing interest-only payments eat into household budgets. For example, interest charges on $50,000 in HELOC debt since the start of 2022 have increased from $140 per month to $310 today.

At the same time, many consumers are grappling with rising mortgage payments, higher energy bills and rapidly inflating grocery costs.

Compounding problems is the fact that many have variable-rate mortgages. These were a more popular choice than fixed mortgages even as late as last February when few anticipated how quickly the Bank of Canada would hike interest rates.

For the most part, many of these mortgage holders have been spared the pain of higher interest costs.

Bank of Canada data show about 75 per cent of variable-rate mortgages have fixed payments. So as rates rose, their mortgage amortization increased instead of monthly payments.

Yet these mortgages have “trigger points” requiring higher payments eventually, says James Laird, co-chief executive officer of Ratehub.ca.

“Most Canadians with this type of mortgage are beyond their trigger points, and that means their mortgage payment is not covering interest costs, which means their principal is going up each month.”

Laird adds these individuals may now see their monthly mortgage payments increase by hundreds of dollars.

“In most cases, the worst that lenders are requiring is that you increase your payment enough so you’re covering the interest.”

Laird notes as a rough example that a homeowner paying $4,000 a month could now be paying $4,800.

Of course, the other group of variable-rate mortgage holders has experienced even more financial discomfort because their monthly payments have increased with each rate hike.

“If you were in a variable-rate mortgage with variable payment, that $4,000-a-month payment, for example, would now be $6,000.”

Given most borrowers had to qualify under the Office of the Superintendent of Financial Institutions (OSFI) stress test to ensure they could afford higher rates, it’s likely they have the capacity to make higher payments.

But it will be challenging.

“It might mean no swimming lessons this year,” Laird says.

In effect, higher rates are now slowly but surely eroding buying power, which is their intent to dampen inflation.

Laird notes the Bank of Canada may now be seeing the results it wants. In December, it indicated for the first time since starting rate hikes that it may halt increasing them in the next few months. “That is a huge change from most of last year” when it explicitly stated more hikes were coming, he adds.

Many mortgage borrowers are also changing tactics when renewing, and are selecting short-term fixed rates, hoping that in three years inflation will be back to normal, and interest rates will be lower.

In the meantime, Canadians struggling with debt should contact their lenders.

“Some lenders are allowing people to extend amortization to reduce payments,” he says. “Others are allowing individuals to skip payments for a few months.”

Laird adds lenders generally have no desire to foreclose — that’s a last resort.

“What they are looking to understand is how you can get back on track,” he said.

Of course, many plans to “get back on track” involve building a budget to reduce other costs to make larger debt payments.

“Starting small and trying to increase savings habits as you make progress is often the most successful way to pay off debt faster,” says Natasha MacMillan, business director of everyday banking at RateHub.ca.

This strategy could involve, for example, at first going out for lunch once a week at work instead of three times, and following up with other small, incremental reductions over several weeks that eventually lead to significant savings that can be used to pay down debt, she says.

Yet if you’re feeling debt is unmanageable on your own, seek help from your lender or debt-management professionals sooner than later, Fry says.

“We don’t want people coming to us with their power being cut off.”