The Bank of Canada has released its annual Financial Systems Review – its yearly take on the top risks facing the Canadian economy – and it doesn’t paint a pretty picture for mortgage borrowers.
Among the top risks outlined by the Bank in this year’s edition is how rising interest rates have strained households and their ability to service their mortgage debt – particularly at renewal time. The central bank has increased its benchmark Overnight Lending Rate a historic eight times between last March and this January, which has upped the cost of borrowing by 4.25%. That’s led to soaring variable mortgage rates, and has pushed fixed rates up as well, due to resulting volatility in the bond market.
In short, Canadian households are carrying more debt in general, with the debt service ratio, or DSR (the portion of debt that goes toward paying a household's mortgage) increasing to over 19% from 16% in 2022. That’s the highest it’s been in over a decade. As well, the percentage of mortgages with a DSR of over 25% has also increased to 29% by the end of 2022, up from 12% in 2021.
The other leading vulnerabilities identified by the Bank included funding shortages as a result of banking instability in the US, as well as climate change and the possibility of a cyber incident targeting financial institutions.
All mortgage holders to feel pain at renewal, says Bank of Canada
So far, according to the report, steeper interest rates have impacted one-third of all mortgages. Of course, those with variable-rate mortgages have already been feeling the brunt of the Bank’s hiking cycle; as their interest rates are directly tied to the benchmark rate, they’ve absorbed a 50% increase to their payments. But according to this most recent FSR, all mortgage holders will feel the impact in some way by the end of 2026, with the median payment increase to be about 20%.
According to the Bank of Canada, this is what borrowers can expect when they renew their mortgages between 2025 - 2026.
- Those with fixed-rate mortgages can expect their payments at renewal to increase between 20 - 25%. Fixed-rate borrowers who’ve been locked into their mortgages over the last few years have been largely shielded from the volatility of the BoC’s hiking cycle and resulting bond yield spike. However, many of these borrowers took out their mortgages when rates were considerably lower; the best five-year fixed mortgage rate was as low as 1.39% back in 2021, compared to 4.49% today – a difference of over 3%.
- As the BoC points out, the impact for variable-rate borrowers will depend on whether they’re on a fixed or variable payment schedule. Those on the latter felt the bulk of the rate pain in 2022, when payments shot up by half. However, those with fixed-rate payments – meaning their monthly payment remains the same, even when the BoC rate changes – may need to increase their payments by 40% to stick to their original amortization schedule.
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More mortgage borrowers will need to extend their amortization
As has been widely reported this year, many of these variable-rate borrowers on fixed payments have already hit a wall in terms of their affordability due to rising costs, crossing what’s called their trigger rate: the point at which their monthly payments cover interest only, and fail to go toward their mortgage principal. To help these borrowers hang on to their mortgages, and to reduce the financial pressure, lenders have been increasingly extending their original amortization schedule beyond the original 25- or 30-year timeline.
In fact, says the BoC, the share of new mortgages with an amortization period longer than 25 years increased from 41% to 46% over 2022, and up 34% from 2019.
A longer amortization period lowers the size of monthly payment – which helps ease debt-servicing costs – but it results in much more interest paid over time, as well as considerably slowing the growth of equity in the property.
The Bank of Canada has gone on the record to say that while these measures provide borrowers with much needed relief, overall it makes these households more vulnerable to financial shocks, such as job loss, or plummeting real estate prices that would wipe out what little equity they may have in their home.
What you can do to minimize the shock at mortgage renewal time
There’s no sugarcoating it; many Canadians are set to endure financial hardship when their mortgage comes up for renewal. But there are some measures borrowers can take now to minimize the impact:
- Connect with your mortgage provider now: If you know you’ll be facing higher rates at renewal, it’s a good idea to explore what solutions may be available from your lender, and how they may impact your bottom line. For example, if you do extend your amortization, will that impact plans you may have had for your equity, such as taking out a HELOC or reverse mortgage?
- Save up to make a lump sum: If you have the financial means, could you start saving now to make a lump sum payment to maintain your existing amortization schedule?
- Rework your household budget: Are there other areas of spending where you may be able to cut back to offset higher monthly payments? For example, funds that were going towards savings, retirement, vacation, or a rainy day fund may be better utilized in keeping your mortgage costs under control, at least temporarily. It’s a great idea to speak to a financial advisor to determine how to rejig your budget, while still keeping your financial goals on track.
The bottom line
The so-called silver lining, according to the BoC, is that most mortgage holders already have some financial padding built in on their affordability, given all borrowers have been stress tested as of 2018 for this very scenario. In its report, the Bank expresses optimism that the payment increase should be manageable for most. Canadian lenders have also proven their willingness to cooperate with affected borrowers to help minimize the impact, a stance officially backed by the federal government; the most recent 2023 Federal Budget proposed a guideline to ensure financial institutions work with borrowers to explore relief options, beyond what’s already become common practice.