When Higher Interest Rates are Profitable

By PAIP Canada staff

            After an eventful 18 months, many Canadians are starting to fear their mortgage renewals. Higher interest rates mean higher borrowing costs and higher monthly payments. In Canada, there are very few mortgages that go beyond the standard 5-year term.

            It’s important not to confuse one’s amortization with the term of a mortgage. The amortization is the number of years one has to repay their mortgage, whereas the term is the number of years during which there is a contractual agreement with a lender to pay a certain rate of interest (which may be variable or fixed).

            As many of these 5-year terms come to maturity, there will be many Canadians who have overextended themselves to be able to afford their new mortgage payments. For those who can, then their expenses will increase… which brings us to an interesting expression. I think Oscar the Grouch is the one who said it: “One person’s garbage is another person’s treasure.”

            What’s going to be a gargantuan challenge for some borrowers is going to be an opportunity for many lenders. As interest rates increase, the amount of interest charged on mortgages will also increase, resulting in higher revenues for lenders. Although these higher revenues will be somewhat offset by higher borrowing costs, the reality is that the very low interest rates we experienced for the past decade have eroded the lenders profit margins.

            The result: this could be an opportunity for investors.

            For those who want to earn higher returns with their capital, there are several options. The first (and easiest) is to purchase a guaranteed investment certificate or long-term bond while interest rates are high. The second is to invest in lenders that have done their due diligence. The last thing anyone wants is to suffer a financial loss if too many borrowers default. That’s what caused the financial crisis in 2008 & 2009. Finally, the insurance industry may offer an above average upside as they maintain a substantial amount of capital (called “float”) until claims have to be paid.

            As always, it’s important to consider all decisions carefully. Barring a crystal ball, no one knows where interest will go next. They could go down, or they could go up. Only time will tell.