After the FED raised interest rates in the U.S., the Bank of Canada did the same. In July the central bank increased rates by 0.25%. This means the Prime lending rate at banks is now 0.25% more expensive for borrowers. What does this mean for Canadians in debt? It means we should reduce our debt balances to normalize our interest expenses and keep our debt load under control. 🙂
How to Adjust Debt Levels Based on Interest Rates
So if the interest rate is higher by 0.25% how much debt should we try to pay down? We can use the following formula to find out. 🙂
Debt amount to pay down = (Interest rate increase amount) x (total debt balance) ÷ (new interest rate on loan)
For example, let’s say I have a variable loan with $100,000 outstanding and my interest rate was 5% before the interest rate hike. So this loan was costing me $5,000 a year in interest payment. But the central bank raised rates by 0.25% so now the loan is costing me 5.25% or an extra $250 per year more than before. I want to know how I can lower my cost of borrowing back down to $5,000/year.
Debt amount to pay down = (0.25%) x ($100,000) / (5.25%)
Debt amount to pay down = $4,761
This means in order for my borrowing cost to stay at $5,000 per year, I will need to pay down $4,761 of my $100,000 debt balance. So at this point I have a decision to make. I can either pay down my debt quickly to bridge the $4,761 gap so I can go back to my initial budget. Or I can accept paying more interest (0.25% or $250 more) every year and work that extra cost into my budget.
Personally I like to adopt a combination of both. 🙂 Earlier this year I used half of my monthly savings to pay down debt, and the other half to invest. But after July’s rate hike I’m putting roughly 75% of savings into debt repayment, and 25% into new investments. Anyway, below are the results of my August finances.
Liquid’s Financial Update
- Part-Time = $1100
- Freelance = $800
- Dividends = $600
- Interest = $300
- Fun = $300
- Debt Interest = $1200
*Net Worth: (ΔMoM)
- Assets: = $1,112,600 total (+900)
- Cash = $3,000 (+500)
- Canadian stocks = $148,500 (+2100)
- U.S. stocks = $90,400 (-1000)
- U.K. stocks = $19,700 (-200)
- RRSP = $82,400 (-700)
- Mortgage Funds = $31,500 (unch)
- Peer-to-Peer Lending = $21,300 (+200)
- SolarShare Bonds = $9,800
- Home = $270,000
- Farms = $436,000
- Debts: = $478,700 total (-2,900)
- Mortgage = $182,100 (-400)
- Farm Loans = $187,800 (-500)
- Margin Loans = $57,700 (-200)
- TD Line of Credit = $11,200 (-1200)
- CIBC Line of Credit = $24,000 (-500)
- HELOC = $15,900 (-100)
*Total Net Worth = $633,900 (+$3,800 / +0.6%)
All numbers above are in $CDN.
Random Useless Fact
According to Wikipedia, Iceland does not have a standing army. But it is recognized as the world’s most peaceful country.