Anyone who’s taken out a variable-rate mortgage in the last three years has been in for a bumpy ride.
What were initially record-low borrowing costs at the height of the pandemic – the Bank of Canada’s Overnight Lending Rate sat an all-time low of 0.25% between March 2020 and 2022 – have since spiked to a 15-year high following the central bank’s rapid hiking cycle to 4.5%.
With the Prime rate soaring from 2.45% to 6.7% today, many variable-rate holders have found themselves on the wrong side of the Bank’s monetary policy plan, facing vastly higher interest rates and payments. Consider the best discounted five-year variable mortgage rate at the start of 2022 was a rock-bottom 0.85%; that’s since ballooned to 5.55% – a whopping difference of 470 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 $3,030 – $1,202 more.
Extra-long mortgages are the new trend
But that’s just for borrowers with adjustable variable payments. Those who have variable mortgages, but are on a fixed payment schedule – meaning their monthly payment doesn’t change along with the BoC’s rate – have had less of that payment go toward actually paying off their mortgage, with more going toward paying interest. The point at which none of the payment goes towards principal is called the trigger rate – and the vast majority of pandemic-era borrowers have hit it.
This is the case for a full eight out of 10 variable borrowers who took their mortgages out between 2020 and 2022, according to an analysis note from National Bank economists Stefane Marion & Daren King. In January, they wrote, “The Bank of Canada's (BoC) latest rate hike will not go unnoticed by the 30% of Canadian mortgage holders who have variable rate mortgages… between 73% to 80% of variable-rate fixed-payment mortgages originated between 2020 and 2022 will have been triggered during the current central bank tightening campaign. For variable rate mortgages taken out before 2020, the proportion will be 63%, compared to only 25% three months ago.”
The good news for affected clients is that lenders are generally willing to help them hang onto their homes, with the most common approach being an extension of the overall mortgage amortization – even beyond the maximum 25 or 30 years mandated at the qualification stage. Extending the mortgage amortization immediately takes some of the pressure off borrowers as spreading payments out over a longer period of time can lower them back into a manageable range.
And these extra-long amortizations are becoming a notable presence in banks’ mortgage portfolios. According to recent regulatory financial disclosures from Canada’s biggest lenders, the number of clients with amortizations over 30 years – or even exceeding 40 years – has skyrocketed. At CIBC, for example, they make up 30% of the books. RBC reported 25%, and 32% at BMO.
It’s no surprise that’s drawn the ire of Canada’s banking regulator; the Office of the Superintendent of Financial Institutions (OSFI) has pointed to the risks of this band-aid approach, including outsized mortgage balances and a greater chance of borrowers defaulting on their mortgages.
In a statement given to Ratehub.ca, Tolga Yalkin, Assistant Superintendent, Policy, Innovation and Stakeholder Affairs at OSFI, writes the regulator expects lenders to ensure changes to uninsured mortgages to "remain prudent", and in line with each lenders' risk appetite. (Insured, high-ratio loans are regulated by the Department of Finance and not OSFI.)
“While increasing amortization is one way to cope with higher interest rate hikes in the short term, it’s not without risk. Extended amortizations will lead to a greater persistence of outstanding balances, and greater risk of loss to lenders," he says.
"Our conversations with financial institutions have emphasized the need to be proactive in managing all types of mortgage accounts, and to act before levels of borrower stress become unmanageable. Ultimately, these are decisions that will be made at the lender level and we appreciate that lenders are working with borrowers to manage cost increases while also ensuring the actions taken remain within the institutions’ risk appetite, including holding appropriate reserve levels."
Simply put, banks carrying portfolios heavily laden with higher-risk clients creates a liquidity risk, which the regulator has named as a key concern in its Annual Risk Report, along with the fact that these homeowners are double squeezed by the downturn in real estate prices.
“The housing market changed substantially over the past year. Following record increases during the pandemic, house prices declined significantly in 2022. OSFI is preparing for the possibility that the housing market will experience continued weakness throughout 2023,” states OSFI’s report.
“The steep increase in interest rates has eroded debt affordability. This is a growing concern from a prudential perspective. Mortgage holders may not be able to afford continued increases on monthly payments or might see a significant payment shock at the time of their mortgage renewal, leading to higher default probabilities.”
The trend has also caught the attention of the Bank of Canada itself; while it has yet to release any hard data about the risks, members of its top brass confirmed to Parliament's Standing Committee on Finance on April 18th that it’s a concern, with Deputy BoC Governor Carolyn Rogers stating, “I think the banks are acutely aware that mortgages that are not getting paid down, that are not getting amortized down, is not a sustainable situation over the long term. But as we understand it, they’re working closely with these borrowers.”
Borrowers will pay more interest over time
While longer amortizations are certainly a key point of concern for the banks holding the bag, the biggest question is whether they truly pose a hazard to borrowers themselves.
For many, this approach has been the difference between losing their home and continuing to carry their mortgage – arguably worth the added risk.
But getting a lengthier amortization will cost you, as you’ll be paying more mortgage interest over a longer period of time – thousands of dollars more. Using Ratehub.ca’s Mortgage Payment Calculator, let’s take a look at the difference even a five-year amortization extension can make to interest paid over time:
- Assuming a borrower has taken out a $500,000 mortgage at a variable rate of 5.80%, made a 20% down payment, and has amortized their mortgage over 25 years, their monthly payment would be $2,512, with a total of $353,560 paid in interest by 2047 – the end of their amortization.
- Extending that amortization to 30 years would lessen their monthly payment to $2,329, but bump their total interest cost to $438,620: a difference of $85,060.
Fixed-rate borrowers to be triggered next
So far, hitting one’s trigger rate has been concentrated for variable-rate borrowers; many fixed-rate borrowers have been able to ride out the last few years of volatility, as they’ve been locked into their terms. But they could be in for a harsh surprise at renewal time, with regulators expecting a new wave of rate sticker shock.
In the Bank of Canada’s latest financial systems review, it outlined a scenario in which fixed-rate borrowers who originally took their mortgages out in the range of 2 - 3% face renewal at median rates of 4.4% and 4.5% in 2025 and 2026. According to the central bank’s calculations, this would cause a 30% median increase in monthly mortgage costs, or $420 more. Analysts expect this could lead more fixed borrowers to extend their amortizations at renewal.
Mortgage arrears data doesn’t reflect the risk
While it remains to be seen just how this higher proportion of extra-long mortgages will play out, it doesn’t appear these increased risk factors are hurting Canadians’ abilities to pay off their mortgages – in fact, it’s just the opposite.
According to data from the Canadian Bankers Association, 99% of Canadian mortgage holders are considered in good standing – “significantly higher than in the US and other advanced economies.”
According to their numbers, of the 5,100,448 total mortgages in Canada, just 7,909 – 0.16% – could be considered “in arrears”, meaning payments haven’t been made for a minimum of three months.
“Mortgage arrears are considered a lagging economic indicator because they typically relate to events that have happened in the past and take time for their financial impact to be felt,” states the CBA. “Payment arrears are driven primarily by employment conditions and major changes in life circumstances that can cause an unexpected loss to a significant portion of household income.”
The association adds that Canada’s banks are “committed to providing appropriate mortgage products and solutions for customers throughout their experience as homeowners, including when there may be a time of financial hardship. Banks actively work with mortgage customers who are experiencing difficulties in the current economic environment characterized by higher interest rates. Several tools are available to assist customers who are experiencing hardship and we encourage customers to speak to their bank about their financial concerns.”
The bottom line
The current economic climate remains volatile, and the chance of higher mortgage rates are not yet off the table. While the Bank of Canada has indicated it will hold its overnight rate steady as long as inflation trends downward, they haven’t ruled out the chance of another rate hike if needed, which would lead to more variable borrowers hitting their trigger rate.
Meanwhile, those coming up for renewal with a fixed-rate term are vulnerable to a much higher rate environment compared to when they first got their mortgage. It’s more important than ever to work with a pro like a mortgage broker, who can assess your risk appetite and help you find the right mortgage product, as economic factors can change quickly.