If you happen to hold an unsecure line of credit with a Canadian financial institution, you may be receiving some troublesome news - payments and interest could be on the rise. This increase is not due to the Bank of Canada raising the Prime rate however. Several of the major financial institutions in Canada are concerned that their earnings may be affected by the historically low interest rates that exist in the marketplace at present and are taking it upon themselves to change things, by increasing their own rates.
TD Canada Trust sent out a wave of letters to customers that hold personal credit lines last week. These letters informed customers that the fixed portion of their revolving credit line would be increasing. This means that even though a customer may have signed up for an unsecured line of credit at Prime + 2.0%, effective March 23 the interest rate will be moved to Prime = 3% or higher.
It's quite disturbing that in a time where we are seeing rising unemployment rates across Canada investment & retirement income seriously eroded that the banks would put an extra squeeze on their credit customers for the sake of the bottom line. Let's get something straight here, TD is not in a position where it is going to lose massive amounts of money because of the low level of the Bank of Canada rate. While TD might not be earning the same level of interest on the Prime rate sensitive products as it was before the credit crisis started, the truth is that the reason for the increase in interest rates is a means to put the company in a position to meet shareholders expectations. In a business that is all about the spread (what a lending institution pays for borrowing money versus what it charges for lending), TD creating a larger spread on these products by squeezing its existing customer base. And it appears that some of the other banks are considering doing the same.
There have also been rumbling in the financial world that suggest a few of the other major Canadian FI's are considering options including increasing their own Prime rate's in order to bolster profits. So while the Bank of Canada Prime rate appears to be staying at 3%, there is no guarantee that the banks will continue to honor this benchmark indefinitely. One thing that can be assured is that if one of the "Big 5" increases their prime rate, it's only a matter of time before the other banks look to do the same. You can bet that the first move will be monitored very closely by the others in the industry and barring a MAJOR wave of public outcry and backlash against the company that makes the first move, that others will follow suit.
What can you do?
There are a few options that you may want to consider should you have a personal line of credit.
#1) Pay down outstanding balance if possible
#2) Consider setting up a Home Equity Line of Credit (HELOC) rather than an unsecured line if you have significant equity in your home (Typically more than 20% or more). HELOC's normally offer much better interest rates as they are secured by a property.
#3) If you'd prefer something less risky than a line of credit that is affected by changes in the prime rate, you could refinance your existing mortgage and lock in a fixed rate. **Fixed rates are incredibly low at the present time. You can lock in an interest rate as low as 4.29% on a 5 year fixed term mortgage. This completely eliminates the risk of interest rate fluctuations for at least 5 years.
#4) If you don't presently own a home with more than 20% equity, you could consider switching from a line of credit to a monthly installment loan. You are giving up the flexibility of being able to adjust your payments, but ensuring that you know exactly what your interest and payment will be.
It should be noted that any credit product that is tied to prime could be quite risky to hold in the future. You can bet that once the markets begin to stabilize that the governments will look to recoup the money that has been used to stimulate the economy. One of the most logical ways to do this is likely going to be through significant increases in the bank rate and therefore prime rate. Lines of credit look very good now with a Prime rate of 3.0% but may not be as attractive should prime double or head even higher. While even the best economists struggle to forecast what types of prime rate movements will occur in the upcoming months, one thing is certain for this type of economic marketplace-it's better to know exactly what you have rather than speculate over where things could get to. As the saying goes, "A bird in hand is better than two in the bush!" It is recommended that unless you are in a position to adapt to potential fluctuations in interest rates over the next several months that you consider moving away from or hedge against products that are tied to Prime.
By no means am I advocating that folks close all lines of credit completely, in fact I strongly recommend that you maintain a line of credit as a "just in case" plan. It may be in a person's best interest right now however, to consider paying these down if you are in a position to do so or look at ‘safer' options until the waves of the recession that we are experiencing subside.
Please contact me at 403-328-1564 or email email@example.com if you have any questions in regards to the information contained in this article. I am always happy to look into individual situations in order to determine what the best situation is.
*Please note: The credit product in question in the preceding document are unsecured lines of credit offered by Canadian financial institutions. These differ from Home equity lines of credit which are secured by a charge on title of a property and therefore carry lower interest obligations (typically Prime or Prime +1.0%). To date, I have only witnessed adjustments to unsecured line of credit.
Unsecured Line of Credit - a line of credit that is not secured against a property or asset .