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OSFI calls fixed-payment variable-rate mortgages “dangerous”

Your mortgage news update for the week of November 3, 2023

Memo 1: OSFI raises alarm on variable mortgages with fixed payments

Canada’s banking regulator has not been shy in the past about voicing its concern over variable-rate mortgages with fixed payments, a mortgage product where a borrowers’ payment remains the same, even as the Bank of Canada increases its benchmark rate.

These types of mortgages have been under particular scrutiny over the course of the Bank’s hiking cycle, as they’ve caused many mortgage holders to enter negative amortization – the point at which their mortgage payment no longer contributes to their principal balance, and services interest only. This is referred to as hitting their “trigger rate” – and it’s happened to eight out of 10 borrowers who took out these types of mortgages between 2020 and 2022, according to data from National Bank.

To address this, lenders have increasingly used tactics such as temporarily extending a borrower’s amortization schedule on paper. It’s a practice that OSFI has raised caution over, given the liquidity risks these mortgages present to banks, and the growing number of borrowers facing rate shock at renewal time – concerns Superintendent Peter Routledge doubled down on in testimony made before the Standing Senate Committee on Banking, Commerce and the Economy on Thursday.

Routledge told the committee that OSFI feels fixed-payment variable-rate products are “dangerous”, given they put mortgage holders in an increasingly risky position as rates rise, going as far as to say that the banking regulator would “like less of that product” in the Canadian mortgage marketplace.

Routledge also spoke to the industry feedback received by the regulator in regards to proposed changes for its Guideline B-20, which will come down the pipe in January. In particular, he spoke to “overwhelming” response from the industry that the existing mortgage stress test – which currently tacks on an additional 2% to a borrowers’ contract rate – has been sufficient. 

He added that while the regulator may “not entirely agree” with that take, OSFI is in no rush to switch up the stress test criteria, given Canadians’ abilities to cope with their rising debt loads thus far, and overall stability of the housing market – a statement that likely has mortgage professionals breathing a sigh of relief. For now.

Memo 2: Soft September job numbers seal deal for ongoing rate hold

It appears the Bank of Canada’s efforts to cool the economy are finally being felt, as the latest job numbers have come in weaker than expected.

According to Statistics Canada, the labour market grew by its smallest margin in over a year in October, up just 0.1% and adding 18,000 jobs. Meanwhile the unemployment rate rose to 5.7%, its highest level in 21 months, marking the fourth monthly increase over a six-month period. The numbers came in under economists’ expectations for 25,000 addded positions, and a jobless rate of 5.6%.

The data also reflects how the job market has rapidly chilled in the last few weeks, in contrast to the 64,000 positions added in September, and 40,000 in August. 

The softer labour numbers further cement the rationale for the central bank to end its hiking cycle, and leave its benchmark rate unchanged for the foreseeable future. Last week, a flat August GDP report indicated that the country is entering a technical recession, with September forecasts suggesting that the economy has contracted for a second consecutive quarter.

“The BoC is still concerned about broader inflation pressures running above the 2% target. But evidence continues to build that go-forward inflation pressures are easing as the economic growth backdrop softens,” writes RBC Assistant Chief Economist Nathan Janzen in an economic update. “We don't expect additional interest rate hikes from the BoC as long as that continues.”

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Memo 3: Another rate hold south of the border

Another sign that prolonged rate relief may be on the way – the US Federal Reserve left its key interest rate range unchanged on Wednesday for the second consecutive time.  

The central bank kept the target for its federal funds rate – the American counterpart to the Bank of Canada’s Overnight Lending Rate – in a range of 5.25% - 5.50%. The decision to hold was based on the fact that financial and credit conditions for American households remain tight, which should put downward pressure on economic activity and inflation. Stubbornly high bond yields – with the 10-year Treasury yield recently hitting a 16-year high – have also effectively restricted borrowing behaviour, as they’ve caused fixed interest rates to soar.

“As expected, the Fed held rates steady today after pausing in September. Given the tightening effect of rising bond yields and our own forecast for economic growth over the coming quarters, the Fed could be done hiking,” writes Francis Généreux, Principal Economist at Desjardins. “It will likely continue to hold until starting to cut interest rates next summer.”

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