Canadians warned on cheap debt in face of Bank of Canada rate cut

The Bank of Canada’s surprise interest rate cut might seem like a gift for consumers taking on debt, but only if they can afford to pay it down over the long term, experts warn.

The reduction in the bank’s overnight rate to 0.75 per cent from 1 per cent is likely to mean lower interest rates on everything from mortgages to car and home renovation loans.

The news is bittersweet, since the drop is due to lower crude prices that are hurting Canada’s oil-dependent economy.

But thanks to oil’s decline, consumers aren’t just getting cheaper gas, but also the added bonus of lower interest rates that make a new car or truck look more attractive now too.

Experts warn too much of a good thing can cause Canada’s record household debt levels to worsen.

“We know that the level of debt is high and it is concerning that Canadians might see this as an opportunity to use the lower interest rates to purchase things on their wish list,” said Patricia White, executive director of Credit Counselling Canada.

While someone already in the market for a home or a car stands to benefit from the lower rates, White says consumers shouldn’t use lower rates as an excuse to get further into debt.

“Credit card interest rates are not likely to be reduced,” White says.

White said consumers could look at this drop in benchmark rates – the first since September 2010 – as an opportunity to reduce their debt.

“For example those with interest rates that are tied to a prime rate of interest like variable rate mortgages, lines of credit and other loans will have their interest reduced,” White says. “This is an opportunity to reduce their debt by paying down the principle owing.”

People looking to renew their mortgage soon can also look for reduced interest rates.

“They need to remember if they can keep their mortgage payment the same or pay more then their debt will be paid off faster,” White says.

TD Bank economist Leslie Preston doesn’t see consumers rushing out to buying big-ticket items and racking up debt based solely on the 25-point basis cut from the Bank of Canada.

She also says the household debt-to-income ratio, while at a record as of the third quarter, has been growing at a slower pace than in recent years, which is a sign it’s getting under control.

“Despite these continued very low levels of interest rates Canadians have already pared back their pace of debt accumulation,” Preston says.

If the bank didn’t increase rates, she says the debt-to-income ratio may have increased anyway as more people in the oil patch lose their jobs have trouble making ends meet.

“The cut was to help consumers out there … deal with the debt burden they already have,” Preston says.

“While some Canadians might ramp up debt a bit, there are a lot of people who aren’t going to be able to spend because they are either losing their job or uncertain about their income because of uncertainty in the oil patch.”

Wednesday rate cut caused the Canadian dollar to fall to around 81 cents (U.S.) its lowest level since April 2009. The lower loonie will have an impact on consumers looking to shop or travel outside of the country, as well as on some goods bought at home.

"While we’re all getting a nice break when we fill up our gas tanks these days, the cost of goods we import will probably rise and the Canadian dollar weakens," Preston says.

Robert Spector, institutional fixed income portfolio manager at MFS Investment Management, believes the surprise interest rate move was designed in part to weaken the Canadian dollar further.

“A weaker currency helps mitigate some of the commodity price weakness and should also boost non-energy exports, a support to growth,” he said in a note. “In fact, the combination of lower policy rates, lower bond yields and a weaker dollar all mean that overall financial conditions eased meaningfully in Canada today.”