The chairman of the U.S. Federal Reserve Board may seem remote on his perch in Washington, but Ben Bernanke has been a ghost at the kitchen table for over five years.
Since the global financial collapse he has led the charge to prop up global markets by lowering interest rates to near zero. That includes injecting cheap money -- that doesn’t exist -- into the system to keep the wheels from seizing up.
History will be the judge, but it can be argued the unprecedented stimulus effort helped keep a lot of people in their jobs and in their homes.
Now, he says the time is coming to wean the economy off of life support through what has been termed “tapering”. The thought of an economy standing or falling on its own has many investors heading for the exits.
No doubt we are entering a no-man’s land but here are three ways tapering could impact your household finances:
Debt burden to get heavier
Low economic growth combined with massive government spending has helped keep borrowing rates for regular consumers at record lows. In spring 2009 the prime rate for major Canadian banks fell to 2.25 per cent. A secured line of credit was as low as 3 per cent and a variable rate mortgage could be as low as 1.5 per cent.
As a result we borrowed in record amounts to helped fuel the fragile economy. Our household debt-to-income went to over $1.60 for every dollar earned from $1 a decade earlier.
Interest rates are already rising as the economy shows signs of life and central banks merely discuss tapering.
We’ve been warned about higher borrowing rates for months now but it is clear over-leveraged households will be in deep trouble if they don’t get debt under control.
The best way to do that is to focus on your highest interest rate debt, such as credit card balances, which generate annual interest in the high teens to high 20-per-cent range.
Talk to your bank about a consolidation loan at a lower rate and a workable payment schedule. Rates vary depending on your relationship with your bank but it could be in the 10 per cent range.
If you have equity in a home, a secured line of credit offers one of the lowest rates available. The standard is prime (currently 3 per cent) plus one per cent but some financial institutions will go lower.
A secured line of credit usually involves legal work, which could cost a few hundred dollars, but it could provide a lifetime of access to cheap money for emergencies or investment opportunities.
Time to lock in that mortgage
Variable rate mortgages are generally tied to the Bank of Canada benchmark rate, which has nowhere to go but up. Right now they are in the mid 2-per-cent range.
Fixed rate mortgages are usually higher, and get higher as the term gets longer. The short term fixed rate is comparable to a variable rate now but homeowners could find themselves in a world with much higher rates all-round at the end of the term.
Many mortgage brokers are recommending a 5-year fixed rate, which is about 3 per cent. You’ll pay more now but after as couple years it could be the lowest rate going.
Fixed income portfolio strategy
Fixed income should always be part of your investment portfolio to balance the risk from equities but as rates rise, yields rise.
To get the most out of rising yields it’s best to stagger maturities and keep them short to take advantage of the highest rates of the day as frequently as possible.
Now pass the potatoes, Ben.