One of the most important things to understand about personal finance is the impact of interest rates. It plays a role in how quickly you can pay off debt but also on how fast your money will grow. If you’ve ever carried high-interest credit card debt, then you’ll know how punitive it is. And on the flip side, if you’ve ever left a sizable chunk of money in your chequing account, you’ll know that it will earn you pennies.
Tracking and understanding the interest rates you are paying or earning can make a noticeable difference whether you are paying off debt or trying to grow your money.
Interest Rates on Debt
Unless you’ve received an interest-free loan from your very wonderful family, debt is not free. Sure you get access to money you might need, but it’s going to come at a cost. And depending on the type of debt you’re taking on, it could cost you anywhere from 3% to 20%+ interest.
Debt goes on a scale based on how secure it is for the bank to lend money to you. Mortgages have the lowest interest rates because the bank has the property as collateral. You can also get secured lines of credit, unsecured lines of credit, student loans, car loans, and, of course, credit card debt. I’m going to show you the impact varying interest rates can have on your debt levels.
If you are paying 8% interest on a $1,000 loan and putting $100 per month towards it, you will have the loan paid off in 11 months and pay a total of $38.10 interest.
If instead, you are paying 20% interest on that same loan it will take you 12 months to pay off, and the interest will have cost you $102.21. That’s an extra $64.11. Not exactly a huge number, but it will only multiply if you have higher debt levels.
Low-Interest Debt Options
If you are currently carrying credit card debt, then your top priority should be reducing the rate you are paying. There are a couple of ways you can do this. First (and easiest) is to call your credit card company and ask for a lower rate. Tell them you’re planning to switch to a different card with a lower rate and you want them to keep your business. If they’re jerks about it, then it can make sense to switch cards. Take a look at the best low-interest credit cards available in Canada. And remember the example above. Sometimes it makes sense to pay an annual fee for a lower rate if you are carrying a balance.
Lastly, you can look into a balance transfer credit card. You’ll move your existing balance to a new card and get a really low-interest rate for a promotional period. You’ll have to pay a transfer fee (usually a percentage of the balance), but it might make sense.
Why High-Interest Savings is Such a Big Deal
Interest on your savings has the exact opposite effect. It’s just as important to seek out the best rate, but this time you want it to be as high as possible. Unfortunately, it’s unlikely it will ever be as high as what you’re paying on any of your debt. Those banks wouldn’t be the banks if they weren’t charging you more than they were paying you.
For things like your emergency fund or money for short term expenses, then high-interest savings is where it’s at. You want that money to be accessible and secure. The last thing you want is for the market to crash and all of a sudden your emergency fund is half what it should be just as your roof starts leaking.
The Best Savings Account
Right now you should be looking for a high-interest savings account that is going to pay you at least 2% interest. Chances are this won’t be a thing if you’re banking at one of the big banks, but you do have other options. I use the EQ Bank Savings Plus Account. They are currently paying 2.3%* interest, and it’s not tied to any bonus offer. If you want to chase interest rate deals, then there are often offers out there, but I don’t like the extra hassle.
Rate of Return on Investments
The last piece of the interest rate puzzle is your investments. Technically the amount your investments gain or lose is called your rate of return, but it’s basically the same thing as an interest rate. The big difference is that you’re not going to know what it is before you buy. Unless you are purchasing a something like a GIC where the bank will give you a guaranteed interest rate to keep your money for a set period, you’ll be at the mercy of the market and your specific investment choices.
If you own stock in McDonald’s and they have a huge scandal where 100,000 people get food poisoning from Big Macs, then your rate of return is going to be negative. If instead, McDonald’s releases a new product that people can’t get enough of then their stock price will go up, and your rate of return will be positive. I’m sure this is what happened when the released the Filet-O-Fish; aka the best thing you can get at McD’s.
Putting all your eggs into the McDonald’s basket isn’t smart investing. You want to be more diversified than that. I’m a big fan of keeping things simple when it comes to investing. Find out more about my strategy here.
The Best Interest Rates Are The Lowest Or The Highest
It’s like the golden rule of personal finance. The higher the interest rate, the more you’ll make, or the more you’ll lose. When paying off debt, you’re looking for the lowest possible rate, and when you’re saving or investing, you want the highest possible rate.
*Interest is calculated daily on the total closing balance and paid monthly. Rates are per annum and subject to change without notice.