Three or four years ago people thought interest rates were going to go negative. There was talk about the bank actually giving you money for free because the interest rate was actually lower than inflation. Imagine… free money. Little did people know, there was no such thing as free money. Those that took the bait found out the hard way this week.
With the Bank of Canada raising interest rates again by 0.25%, we have now seen interest rates go up almost 1 full percent in the year. Though this isn’t much, it certainly is newsworthy. Many people thought that interest rates would never go up again. 0% prime rate was going to be the the norm and 2% mortgages were all the rage. Many people took out loans for houses, cards and renovations that looked extremely cheap to finance, but now they are starting to feel the pinch.
Recent studies by MNP Ltd and Environics have shown that the increase in interest rates are hitting the youngest generations hard. Why is that? Large student loans and large mortgages on newly bought homes over the last decade have put young Canadians in their most precarious financial situation ever. Many thought that interest rates would never rise and loan repayment would be manageable. They were wrong. When the media starts publishing reports from debt consolidators rather than taking advertising revenue from banks pushing mortgages or realtors telling your “now or never”, you know the tide has turned.
Surprisingly, those in the worse situation aren’t the poor. It’s in fact the middle, to upper middle class who are feeling the greatest pinch. These are well educated, good earning individuals that just didn’t understand the consequences of taking on too much debt. Now they know.
No Such Thing As Good Debt
We were all brainwashed into thinking that there is such a thing as good debt and bad debt. That’s kind of like saying there are good STDs and bad STDs. Some will kill you, some will not. There’s no such thing as a good one. They’re all bad!
As the diagram shows, most people took out massive loans to buy houses, but on top of that they took money out of their homes through lines of credit to buy more things like an education, renovations or a rental property. In some circumstances these loans might make sense, but in most cases it’s a bad idea. Debt is what prevents many of us from ever achieving financial independence. Instead of having our money work for us, we borrow from our future to help us now.
What’s really scary is that those numbers are showing massive amounts of debt being held in large successful cities in Canada. No doubt the mortgage numbers represents young home buyers who have purchased their homes in the last 5 years. Remember that these are average numbers, for every mortgage free old geezer, there’s a fresh young grad that has a $400k mortgage, or a young power couple with a $800k mortgage after buying a $1.2M home.
These are scary numbers. Young people, the driver of our future economy and the main consumers in Canada, are swimming in mounds of debt. What’s going to happen when interest rates finally reach 5%?
Going Cold Turkey
As interest rates start rising and normalizing back to the 5-6% range, now is the time to stop gorging on debt. Stop using line of credits to buy things that you cannot afford. If you don’t have the cash, then don’t buy it. Don’t take out a large mortgage. Stop increasing the HELOC amount to fund vacations and renovations. The time for cheap money has come to and end. It’s now time to face the reality that things you may want now are no longer financially viable.
It seems many Canadians were living in a dream. Rising home prices and low interest rates allowed many home owners to withdraw money from their rapidly rising home valuations, but now things are starting to change. Debt that has been accumulated over the last few years, now has to be repaid. Call it a debt hangover if you wish, but people who partied since the Great Financial Recession on borrowing money are in for a hard lesson.
There’s nothing wrong to saying “no” to debt. If your bank offers you a limit increase on your credit card, say “no”. If you are tempted to renovate your home to keep up with HGTV episodes, say “no”. If you think you deserve a trip to Bora Bora using your HELOC, say “no”. Seriously, it’s time to go cold turkey.
Bankruptcy is financial suicide. Some people think it’s just okay to walk away from their financial obligations by declaring bankruptcy. It’s the easy way out for not admitting to financial mismanagement, but given the fact that a bankruptcy will linger with you for life, it’s something to avoid.
Bankruptcy is not a get out of debt for free card. It carries a negative stigma for the rest of your life when trying to apply for credit. Don’t be surprised that home ownership will never be attainable again after bankruptcy. Trying to get a new car loan? Forget it about. It’s also possible to even get rejected for a cell phone plan. No more iPhone X 🙁
If debt is starting to get overwhelming, then it’s a sign that something should be done about it soon and now! Start by cutting back on spending and paying down the debt to make it a more manageable amount as interest rates start to rise. Considering selling the home if mortgage payments are already too tight. Just remember that if other people start having issues with their mortgage payments, it’s best to get out now while the market is still ripe. Don’t want to wait too late when everyone starts selling.
Yes, these might be drastic actions, but it’s important to avoid bankruptcy if possible. Getting debt to become manageable level is more important than owning a home or driving a fancy car. Besides, owning the bank is more lucrative than owning a home.
Say No To Debt
Just like smoking, drinking while driving, or jumping off the CN tower without a parachute, Canadians need to start saying “no”. Say no to debt. The harsh truth is, we’re not “Richer than we think” despite what the banks are telling us. It’s our own responsibility to take ownership of our actions and that means learning to say no to debt.
Over the next couple of years, Canadians will have to start learning that buying the things we want will become harder and harder as the cost of credit goes higher and higher. It’s going to be a tough lesson to learn for everyone, especially those who have gotten accustomed to getting whatever they want whenever they want on credit.
Before we reach that point, it’s important now to take the necessary steps to get our debt back to a manageable level. Now is the time to start tightening the belt and pay back our debt obligations. The dark clouds of higher interest rates are coming. You better be ready for it.