Increased Interest Rates Means It’s Time To Revisit Your Cash Management

It’s been over a year since the US Federal reserve (and eventually the Bank of Canada) started increasing interest rates. In a world of higher rates, there are several ways you can optimize your cash. In this article we’ll explain three of them:

Slow down your mortgage payments if you have a low fixed rate:

Most people are taught to avoid debt at an early age, but it’s important to understand that debt is a tool you can use to your benefit. If you locked in a fixed rate mortgage under 2% before rates started increasing, congratulations! In this case, you should only make minimum required payments toward your mortgage. Why? Because you can earn much better rates using high-interest savings products than you could in 2021. Here’s an example of how you can benefit from re-allocating your cash: Chris and Jess have been making an extra $10 K annual payment toward their mortgage, which is fixed at 2% until Dec 2028. Now that they can earn a better rate of return on their savings, they can deposit this $10 K into a high-interest savings fund earning 4.3% over the next six years. They still have room in their respective TFSAs, so they won’t be taxed on the interest they earn. After six years they can make a lump sum payment against their mortgage prior to renewal. In this scenario, there is a $3,750 difference in interest earned over interest paid on the $60 K of deposits/mortgage payments over the six years.

Complete a T1213 to reduce source Withholdings:

I know, getting a $20 K tax refund feels great; I hate to break it to you, but a tax refund is just the government giving your money back to you and not to make you feel worst, but they don’t pay it back with interest! Instead of waiting until next April to get your refund, you can fill out a T1213 form to request that your employer lower your source withholding tax. Once approved you can direct your extra monthly cash-flow toward extra mortgage payments or if you’re mortgage is fixed at a low rate, saving the extra in a high-interest account. $20 K annually is ~$1,650/month of extra cash flow. Over a year, this extra payment translates into ~$500 of interest savings on a 5% mortgage. This may not seem like a lot, but it adds up over multiple years.

Open a home equity line of credit and make lump sum mortgage payments.

Some people like a keep a lot of cash in a chequing or savings account for emergencies, and it’s great to have an emergency fund with three months of expenses or more, but this can be an inefficient way of managing cash if you have a variable interest mortgage. You would be better to use the cash to make a maximum prepayment and use the home equity line of credit in case of emergency. This way you can use your cash to reduce the mortgage interest and still have a plan if you need cash. *Note this strategy makes much more sense when the mortgage is variable because the rate on the HELOC should be very close to the rate on your mortgage, so by using the HELOC, you’re in the same position you would have been if you had to use the emergency fund so there’s no real downside. The upside is that if the emergency never comes, you’re making better use of your cash to reduce your interest expense.

Conclusion

The strategies above are not going to make you rich, but small improvements compounded over multiple years can make a huge difference in helping you meet your retirement goals. Optimizing cash management is one way to create better long-term financial outcomes.