Dealing with Debt and Variable Rates

With rising interest rates, knowing which debts to pay off first can go a long way. As banks increase rates to combat inflation, this tends to increase the cost of borrowing. Especially if you hold any variable rate debt. 

Since the prime rate has been adjusted several times this year to try and keep the economy within certain margins and control inflation, those with debt that has a variable interest rate have undoubtedly noticed an increase to the cost of borrowing and their payments.

Credit that Costs More

When your debt is tied to a fixed-rate, you are less likely to have concerns. But if your debt is connected to a variable-rate option, you can expect the cost to increase. 

Personal loans – borrowers sometimes opt for variable rates even when they are completely aware of the potential risks of rate increases.

Mortgages – variable rate mortgage borrowers will feel the increase most and might consider refinancing for a fixed rate solution. 

HELOCs – these credit lines are often variable, see if your lender can offer a fixed rate.

Car loans – these loans can be fixed and switch to a variable rate. Review the terms and monitor or refi if necessary.

Credit cards – almost all credit cards have a fixed rate in Canada, but there are some that are presented as “low interest rate” cards that can have a variable rate. 

Since a variable interest rate can drive up the cost of certain debts when the overnight rate or prime has increased, taking a look at certain debts and forms of credit is a good place to start for monitoring and managing finances.

Focus on High Interest Debts

It is unlikely that you would be able to zero out or pay off credit balance of all variable rates, like a mortgage, car loan or even a personal loan. Also, this can trigger penalties like early repayment fees for a loan, and can cost tens of thousands of dollars when it’s for a mortgage. 

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Since debt with a higher interest rate generally costs you more money, this can be a good place to start. You might make a list of each type of debt that you have and list them by interest rate from highest to lowest. Ensure you continue with payments on all other debt and the minimum owed each month. Placing a focus on paying off debt with the highest interest and allocating any additional funds can help with getting debt under control. This is sometimes referred to as the debt avalanche method. It can be a slow process, but this method often saves you the most over the long haul.

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Alternatively, you could look at the debt snowball plan, where you make the minimum monthly payments, but organize and focus on paying off the smallest balances owed instead of interest rates. Many find this method more gratifying since you are quicker to pay off a debt. Remember  that the debt with higher interest rates often costs more. 

Debt Direction

If you’ve carefully read the terms of your loan agreements and know which (if any) might have early repayment fees, you can weigh the pros and cons and review which direction to take and whether early repayment including penalties is in your favor over paying the interest for the term and sticking with the payment plan. 

Creating a manageable pay schedule and making your debt payments on time is crucial to managing your credit score. Your payment history plays a big part in how you might rate, and qualify for later. So it’s imperative to carefully manage your finances and credit score since it can have a lot of influence when borrowing and what sort of interest rate you might be eligible for in the future.