March 19, 2008, 6:13 am

How interest rates affect our personal finance

by: The Financial Blogger    Category: Investment, Market and Risk,Personal Finance
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I recently wrote an article on the possibility of having a recession and the fact that the Bank of Canada dropped their interest rate by 50 points. Then, this Monday, JP Morgan announced that they will buy Bear Sterns for 234M$ (2 bucks a share). With this kind of news, you can rest assured that the interest rates won’t increase tomorrow regardless of which side of the border (CAN – US) you are. So let’s have a deeper look at how interest rates affect your personal finance.


Variable rates are smiling

If you have a variable rate mortgage or a HELOC, you are probably dying of laughter. Thanks to the Bank of Canada, I am now paying more capital than interest on my mortgage payment! Therefore, I am now able to divide my mortgage payment in 3 portions: the interest due, the principal and a Smith Manoeuvre Contribution.

Unfortunately, a low variable rate is a double edge knife. On one side it becomes easy to pay down your debt. On the other side, it is easy to fall into the deadly spiral of credit. This is exactly what happened to several Americans where they thought that refinancing their property every two years was a good way to finance their lifestyle. Since the interest charged on a mortgage is tax deductible for them, they didn’t see any reason why they should not do it. We all know the rest of the story.

Leveraging become more appealing

The markets are down, the interest rate is low; everything seems to be in place for a good leverage strategy. You might eat your socks for the next two years but the spread between the interest rate paid on a leverage loan and the possibility of what you can earn on the market is very interesting.

Our Buying Power Drops

This is very ironic; while you borrowing capacity increase, the money you are about to borrow worth less… Hum… who’s winning then? The answer lies within the good you are about to purchase. Everything that is made in your country should keep their price.

However, since our dollar worth less, our buying power out of our own country decreases as well. Therefore, you might pay a higher price for goods that are produce elsewhere. As Canadians, you probably noticed that we benefitted from a strong dollar (compared to the USD) since several prices decreased. Since both Canada and US are dropping their rates, our buying power should remain stable for now.

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