TFSA Interest Rates
A TFSA can hold many different types of investments inside it, each with their own interest rates and earning potential. Interest rates are generally applicable to situations where you are “renting” out your money: cash, GICs, and bonds. Vehicles where you are investing in earning potential, such as mutual funds, stocks, and ETFs don’t have interest rates per-se, rather they have price that changes daily according to market forces.
How interest rates affect TFSAs
Inflation generally drives interest rates up in an attempt to get back the value of the money originally lent out.
The Bank of Canada will often push up short-term interest rates in an attempt to keep inflation at bay. When the economy is down, they do the opposite in an attempt to encourage borrowing.
While interest rates can affect all investment types, it most affects bond prices. This is an inverse relation: interest rates go up and bond prices go down, rates go down and bond prices go up. The “younger” the bond (ie one with a maturity date far in the future) the more noticeable the price change.
Inflation is the sustained increase in the prices of goods and services over time. Because the value of the actual money hasn’t changed ($1 is still $1), this means your value-per-dollar goes down. In essence your purchasing power has gone down.
Because of inflation you may not be earning as much inside a TFSA as you thought. Use the formula (Interest – Inflation) = Actual earnings (aka your ‘real return’ vs a ‘nominal return). For instance, if you have money inside a TFSA earning at 3% but inflation is sitting at 2%, you are actually only earning 1% in real profit. Inflation in Canada has sat around 2-2.5% for the past several years (though in 2021-2022, this appears to be rising quickly), so it’s a good idea to make sure your investments inside your TFSA are growing by at least that amount in order to break even over the long term.
How interest rates affect borrowing money for a TFSA
When borrowing money to invest in your TFSA, your interest rate will depend on your creditworthiness and how much you are borrowing. If you are an excellent candidate you may be offered the financial institution’s “prime rate” (usually around 3%). But most people will be offered somewhere around prime + 1-2%.
Other factors include the length of time you plan to borrow the money for. Shorter-term loans (up to a year) will generally get you a lower interest rate from the banks since they can more easily predict market forces and economic climate over the short term. If you plan to borrow for a longer period of time you will likely have to put up with a higher interest rate since economic uncertainty goes up over the long term.
How to get the best rate of interest when borrowing for a TFSA
Even though you can’t control market forces or the general economy, you can increase your chances of getting a favourable interest rate when borrowing for your TFSA:
- Ask for a lower rate than what is advertised. Just like shopping for a car, it’s negotiable!
- Maintain a good credit rating: things like making your car payments on time and paying off your credit cards can do wonders for your credit rating, making you a better candidate for preferred interest rates.
- Shop around and try the credit unions if your big bank can’t give you a rate you’re happy with.