As mortgage rates have surged over the past two years, borrowers – particularly those who took out their mortgages during the pandemic – have seen considerable increases in their debt obligation costs.
Following a historic nine rate increases implemented by the Bank of Canada between March 2022 and June 2023, the Prime rate in Canada – the benchmark used by lenders to set their variable-product pricing – has risen from 2.45% to 6.95%. As a result, variable mortgage rates have ballooned from their rock bottom of 0.85% back in January 2022 to 5.8% today – a whopping difference of 495 basis points. When it comes down to dollars and cents, a borrower absorbing that difference would have seen their payment rise from $1,828 per month to $3,102 – $1,274 more.
Those who purchased their homes around February 2022 – considered to be the market peak in terms of pricing, when the national average hit $816,720 – are finding themselves in a particularly challenging scenario, as rapidly cooling housing prices and rising interest rates have whittled away their equity in addition to inflating their mortgage costs.
The trigger rate effect
For variable-rate mortgage holders with adjustable payments, the bulk of the pain has already been felt as their payments have increased in tandem with the BoC’s rate hikes. However, those who are on fixed-payment schedules have had the option to defer the financial impact by keeping their monthly payments the same, in exchange for less of that payment going toward their mortgage principal.
However, over the course of the BoC’s hiking cycle, many of these borrowers have hit what’s referred to as their “trigger rate” – the point at which their payment no longer contributes to their principal mortgage balance at all, and instead covers only interest.
When this occurs, borrowers must take action to restore their ability to pay toward their mortgage principal. This can come in the form of increasing the size of their monthly payment, making a large lump sum payment to reduce the overall mortgage size, or – as has increasingly been the case – extending the overall amortization period of the mortgage. This is also referred to as “negative” amortization, as the unpaid interest is then rolled into the principal mortgage amount, and the overall size of the mortgage grows – along with the time frame to pay it down.
In Canada, the amortization period for new mortgages is capped at 25 and 30 years, depending on whether the borrower is considered high- or low-ratio, with a down payment below or above 20%. However, once the mortgage is on their books, lenders can take the liberty to extend it further if need be – even decades longer, reaching lengths of 70, 80, or 90 years. The trouble comes at renewal time when borrowers will need to return to their original amortization length, and will face considerably higher payments.
The financial impact of a 90-year mortgage
But what would be the financial impact if these borrowers actually had to carry a nearly century-long mortgage?
To illustrate how this would translate into dollars, Ratehub.ca crunched the numbers, based on a theoretical mortgage loan with a principal amount of $500,000, and mortgage rate of 5.80%.
In the most extreme scenario, extending an amortization from 25 to 90 years effectively lowers the borrowers’ monthly payment to $2,429.97 from $3,160.66 – a difference of $730.69, and -23%.
However, the overall costs for the mortgage balloons over the 90-year timeframe, with the total amount paid rising to $2,624,469.50 – an increase of 177%! The amount of interest would rise by 374%, to $2,124,469.40.
Difference between 90-year and 25-year amortization
Extra-long mortgages spark warnings from banking regulator
The number of borrowers impacted by extra-long amortizations is not insignificant – and that’s raising alarm bells with the Office of the Superintendent of Financial Institutions (OSFI), the regulatory body that oversees the lending criteria for Canada’s banks.
In fact, according to research from National Bank, a full eight out of 10 variable borrowers who took out new mortgages between 2020 and 2022 have encountered their trigger rate, and extra-long amortizations now account for between 25 - 32% of all mortgages on big bank books, according to recent regulatory filings.
Various representatives from OSFI have voiced concerns to the media in recent months that banks should ease off the practice of extending amortizations, calling them a band-aid approach and warning they pose increased risk of borrower default. The pain will be especially apparent when many of these borrowers come up for renewal – data from the BoC forecasts variable-rate borrowers on fixed-payment schedules could see their payments increase by 40% should they come up for renewal between 2025 - 2026.
Fixed-rate mortgage holders aren’t exempt either. Currently, while extended amortizations are a concern mainly facing variable-rate mortgage holders with fixed payments, mortgage holders who locked-in at a historically low fixed rate during the COVID-19 pandemic may also be faced with similar challenges when they come up to renewal time. These borrowers will either have higher mortgage payments or will have to extend their amortization. The same BoC data finds these borrowers will see payments increase 20 -25% upon renewal.
OSFI has hinted that it may address the issue by limiting the number of highly-indebted borrowers a bank can have on its mortgage balance sheet, as part of its next update to its B-20 guidelines.
However, new guidelines from the Financial Consumer Agency of Canada (FCAC) were released this week, spelling out expectations for lenders to provide support to mortgage borrowers who are considered "consumers at risk". According to the guideline, this includes support for variable-rate borrowers on fixed payments who "have seen a materially larger portion (or all) of their payments allocated towards the increased interest costs or who may be facing negative amortization."
"FCAC expects an FRFI to design its policies and procedures with consideration for all available mortgage relief measures that may be appropriate for consumers at risk, such as waiving prepayment penalties, waiving internal fees and costs, not charging interest on interest, and extending amortization," reads the guideline. However, it does specify that in cases where a lender does extend an amortization, that it would be for "the shortest period possible," and "taking into consideration the ability for the consumer at risk to restore the amortization to the original period."
What borrowers can do to reduce the impact of rising rates
Make a lump sum payment: Given today’s challenging economic climate, many borrowers will find themselves hard-pressed to allocate additional funds to their mortgage; given many live on a fixed budget, doubling their mortgage amount isn’t financially feasible. However, it’s highly recommended that when possible, borrowers make a lump sum payment against their mortgage. This will arguably have the biggest impact on their mortgage payments and the interest paid.”
Keep an eye on rates: While the Bank of Canada has been mired in its steepest hiking cycle in decades, today’s rate hikes won’t last forever; analysts are largely anticipating one last increase this July before the central bank resumes rate holds for the foreseeable future. Rates could start to come back down in the second half of 2024, should the economy enter a recession.
This will provide borrowers with the chance to get ahead on their payments – while it’s anticipated that mortgage rates will remain elevated in the coming years, borrowers in this position might have the opportunity to make lump sum payments 5-10 years from now when rates may be lower.
Increase your payment size upon renewal: Anything that helps reduce the mortgage’s overall amortization will help lower the overall interest paid over time.