Are we Collectively Holding a Financial Grenade?

By Ryan Goldsman, CFP®, PAIP®

“All I want to know is where I’m going to die so I’ll never go there”
          - Warren Buffett & Charlie Munger

I’m not sure who actually stated it for the first time, but it’s definitely worth thinking about. Put another way, we knew the train was going to come barreling down the tracks at some point, but we didn’t act until it was too late. Very few took refuge or planned accordingly.

With interest rates reaching a multi-year high, many Canadians are now starting to feel the pinch, but that’s only one side of the problem. From the perspective of the lender, there’s a greater number of borrowers who will be late in making their payments, and some will potentially default. These losses eventually lead to higher rates for everyone.

The good news for Canadians is that amortizing loans have a finite life. Bad assets eventually move off the books and time continues to move forward. We experienced this first hand in the years following the great recession (2008-2009). It took time, but a new normal was established – albeit with much lower interest rates.

When considering the factors that are currently in play, it’s very clear that Canadians are experiencing a headwind instead of tailwind, and it’s probably not going to end as well as many hope. The ultra-low interest rates that we experienced over the past decade made it very difficult for the Bank of Canada (BOC) to manoeuvre. It made the country much more vulnerable.

For those who are renewing their mortgage (or will be in the next few years), then planning for higher payments is one of the ways to avoid the sticker shock. Higher interest rates lead to higher monthly payments.

A second alternative to make payments more manageable is to extend the life of one’s mortgage. As an example, for those who purchased a home five years ago (with a 25-year amortization), then there may still be 25 years remaining after the initial renewal comes due. Alternatively, it may not be possible to remain in one’s home due to the higher mortgage payments.

Compounding the problem, many communities are now increasing property taxes due to the higher expenses brough on by inflation. Almost everything is starting to cost more across the board, and it’s not going to get any easier in the short or medium term.

Once the rate of inflation slows, then the BOC may provide some relief. Canadians and industry professionals both expect interest rates to decline once again, but Canadians should not expect rates to return to the rock bottom levels f the past decade. Instead, the BOC will allow itself more breathing room.

For those currently under more financial strain that ever, there is good news, and there is bad news: things will eventually get better, but they’ll never be as good as they were before. We learned the same lesson after the great recession, and now the next generation is going to face something similar.

Of course, the question that investors should ponder, is what are the ramifications of higher interest rates? If we can figure that out, then maybe we can determine where our investment dollars can grow. It worked the last time.