Interest rates: What they are and what they mean for your wallet
Interest rates—they're constantly fluctuating, but what do they mean for you and your hard-earned money? It’s important to understand how these seemingly small percentages can have a big impact on your financial well-being.
What are interest rates?
When it comes to getting a loan, the interest rate is the amount of money a lender charges a borrower. Interest is charged as a percentage of the principal, or the amount loaned. Think about when you pay your mortgage, car loan, student loan or other personal loan. Part of your payment goes towards paying down the principal. But part of it also goes to paying interest to the bank, mortgage broker or person you borrowed from.
Interest also applies to savings. When you deposit or invest money with your financial institution, they pay you interest in the form of a percentage of the amount you deposited or invested, for saving or investing those funds with them.
What happens when interest rates change?
Market conditions, inflation and Bank of Canada policy all impact the current interest rate. The Bank of Canada, our country’s central bank, considers all these factors when it sets its interest rate. The interest rate set by the Bank of Canada is called the overnight rate (also known as the policy rate).1 This overnight rate influences the prime rate that your financial institution will charge you for your mortgage or loan. And it also impacts how much you’ll earn for saving or investing. The Bank of Canada meets eight times per year, and they usually announce any changes to the overnight rate during these meetings.
Rising interest rates
The Bank of Canada typically increases the overnight rate when inflation (the cost of goods and services) rises. When interest rates rise, it becomes more expensive to borrow money. But it's not all doom and gloom. Sure, your variable-rate mortgage payments may increase, but it also means that your savings accounts and investments could earn more. Banks tend to increase the interest they offer on savings when the Bank of Canada raises its rates. So, if you've been putting away money for a rainy day, higher interest rates could help your nest egg grow faster.
Falling interest rates
On the flip side, the Bank of Canada typically cuts the overnight rate when inflation falls, or when the Bank worries that inflation will be less than 2%.2 When interest rates fall, it’s cheaper to borrow money. This means it’s a great time to consider refinancing your mortgage, or locking in a fixed rate. Lower interest rates mean you'll pay less in interest over the life of your loan, which could save you thousands of dollars in the long run. However, this also means the interest you’re earning on your savings will decrease too.
Navigating changing interest rates
Interest rates don't just affect your mortgage and savings; they also influence the cost of consumer goods and services. When interest rates rise, it costs more for businesses to borrow money for expansion or inventory. To offset these costs, they may increase the prices of their products, which means you could end up paying more for your daily essentials. But when interest rates fall, businesses can borrow money more cheaply, which could lead to lower prices and more affordable goods and services.
So, what's the secret to navigating the ups and downs of interest rates? It all comes down to being informed and proactive. By understanding how interest rates work and how they impact your personal finances, you can make smarter decisions about your money. Whether you're looking to save more, pay off debt, or invest in your future, knowing the ins and outs of interest rates can help you achieve your financial goals.
Next steps: Be aware and prepare for the next interest rate change
Ready to take control of your financial future? Let's chat! We're here to help you understand how interest rates impact your unique financial situation and create a plan that works for you. Together, we can navigate the ever-changing world of interest rates and build a strong foundation for your financial success. Don't let interest rates intimidate you—with the right knowledge and guidance, you can make them work in your favor.