Interest rate hike: 4 ways Canadians should prepare

The Bank of Canada is expected at some point in the year to hike interest rates, and even a small andgradual hike wouldaffect millions of Canadians with car loans,mortgages andlines of credit.

"Definitelynotgoing totake much of a hike to make adifferenceand impact your payments," says Toronto-basedfinancial planner Jason Heath."As soon as there's aquarter-pointincreaseininterest rates, I think it'sgoing to have animmediateimpacton people'spsychology."

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A Canadian increase would likely follow an American rise in the rates and may not come until the third quarter. But by the end of the year, Canadians could be facinga1.5 per cent benchmark rate(it's currently at 1.0 per cent) and higher borrowing costs.

1. Pay down debt

Some consumers may be tempted to make large purchases before the rates go up, but analysts adviseagainst that, saying consumers should instead focus on paying down debt first.

"I find that there's a feeling that because interest rates are low, you shouldn't paydown the debt what's the point, what's the rush? But now may be an opportunity to focus more aggressively on debt repayment while interest rates are low," Heath says.

"If youmake a lumpsum paymentagainsta mortgageor a line of credit,that'sgoingdirectlyto your principaland reducing the interest youre goingto pay in the future when rates do rise."

Although people may be tempted to pay down mortgage debt first, they should insteadfocus on department store orcredit card debtwhere interest rates are much higherand unlikely to be affected by the Bank of Canada interest rate hike.

2. Lock in mortgage or line of credit rates

Common advice, says Ian Lee, assistant professor at Carleton University's Sprott School of Business,is that those who have a floating-rate mortgage or floating-rate loanshould lock in with a fixed interest rate.But the downside, he noted, is having a fixed payment, meaning the principaland interest must be paid back over a specifiedtime, unlike, for example, a home equity line of credit.

"But thequestionwas how will yousave more money, and the answer is: lock in your debts," Lee said."If youhave avariablerate mortgage,switchto aclosedratemortgageand lock it in for as long aterm as possible, because once those rates start going up, we're never going to see them again."

3. Don't rush to buy a home

Higher interest rates could also lead to a correction in the housing market.

"The big issue as far as I can seeis that people panic and think they have to get into the housing market before interest rates climb. But they have to recognize the overall long-term impact of interest rates actually climbing," saysLaurie Campbell, CEO of Credit Canada Debt Solutions.

Homebuyers who rushout to purchase homes to beat a spike in ratescould end upwith homes dropping in value.

"I thinkpeoplehave to be vigilant about any bigpurchasesthey may be making in the next little while.Housing in particular," Heath says. "Ifsomeoneis considering purchasing a house, theyhave to reallylookat more normalinterestratesduringtheirbudgeting."

4. Sell the house?

Some Canadians have financially overextended themselves in their homes, leaving them barely anywiggle room in the event of an interest rate increase,saysChad Viminitz, an Edmonton-based financial planner and author of Money Assassins.

"To really put themselves in a good financial position, saving a cup of coffee or doing all those things you hear about, is really not goingto help," said Viminitz.

"Because when you already have everythingbuilt into your house and into your vehicle and youget a one per cent change in interest rates?Well, a one per cent change on 50 per cent of your spending youre in a really really difficult position."

And it's a development that could force homeowners to make some difficult decisions, he says.

"If someone has the courage and that long-term view, and if they just boughta house in the lastcouple of years and they arereally worried about interest rates going up, it may also be the righttime to sell and to downsizeto something that is more affordable,"Viminitz suggests.

"And that s difficult. But we do come across a few peoplewho said, 'I needto make a change, becauseI can'tafford this, and saving money on coffee is not goingto do this.'"