Canadians have seen rent, food and gas prices soar in the past year, and now hundreds of thousands of households can expect another hit: rising monthly mortgage payments.
Many borrowers who took out variable-rate mortgages during the height of the housing market frenzy in 2021 and early 2022 could face higher payments next month -- or even the need for a lump-sum payment on their mortgages.
The vast majority of variable-rate mortgages have fixed monthly payments, but soaring interest rates mean many of them will likely hit their “trigger rates” this fall, forcing an increase in payments.
Around 15% of the mortgages in Canada are in this group, according to an estimate from Ben Rabidoux, a prominent housing market analyst. That amounts to around 750,000 mortgages.
A “trigger rate” is the point at which interest payments eat up all of a monthly mortgage payment, and the borrower is no longer paying down the principal they borrowed -- something that’s not allowed under Canadian lending rules.
This means borrowers will be contacted by their lender and, typically, given the option to either increase their monthly payment, or make a lump sum payment against their mortgage to lower the amount owing.
Depending on their mortgage, borrowers may also have the option to switch to a fixed-rate mortgage – though Rabidoux and others warn there’s a chance borrowers could end up locking themselves in at unnecessarily high rates.
Canadians took out $260B-worth of variable-rate mortgages between March 2021 and February 2022, at a rock-bottom average interest rate of 1.58%, Rabidoux noted in a Twitter thread.
The “average” of these mortgages will hit their trigger rate if the Bank of Canada (BoC) raises its key lending rate by just one more percentage point, or 100 basis points in the language of the financial industry, said Rabidoux, founder of North Cove Advisors and Edge Realty Analytics.
The BoC has already raised its rate four times this year, taking it from 0.25% to 2.5% in the fastest pace of rate hikes in three decades. That has increased the interest portion of variable-rate borrowers’ monthly payments, but so far, few loans have hit their trigger rates, and monthly payments have remained steady.
The bond markets are pricing in a 75-basis-point rate hike when the BoC announces its policy interest rate on Sept. 7, but many think it could hike a full 100 basis points, as it did in July.
An increase in mortgage payments could put further pressure on the consumer economy, with shoppers already cutting back due to rising prices.
Royal Bank of Canada, which says it has about 80,000 mortgages that will hit their trigger rate with the next few rate hikes, expects the average payment increase to be around $200 per month.
Rabidoux noted that these borrowers all passed the mortgage stress test, which last year would have required them to qualify for a loan at a hypothetical rate of 5.25%.
“Most borrowers will be fine, but not all,” he said in an email exchange with STOREYS.
Some Borrowers May "Panic"
Variable-rate mortgages have always been less popular than fixed-rate ones in Canada, typically accounting for less than a quarter of all mortgages. But during the pandemic, the rates on variable mortgages dropped far below those on fixed loans, and by the start of this year, a third of all mortgages issued were variable.
This means that a higher-than-normal share of mortgage borrowers are exposed to fluctuating interest payments from month to month -- at a time when rates are rising quickly.
Rabidoux suggested some of these borrowers may “panic” and switch to a fixed-rate mortgage out of fear rates will rise further -- what he described as “a self-induced payment shock to avoid a potential future payment shock.”
Locking in a fixed rate is a gamble at today’s interest rates, and some mortgage experts recommend against it. Bond markets are pricing in at most a few more rate hikes from the Bank of Canada, and interest rates are expected to fall from those levels in the long term.
All the same, mortgage rates “probably aren't going back down any time soon,” Rabidoux said. “Long story, but if I had to bet on it, I'd bet we've seen the lows in [mortgage] rates for decades.”
Besides the hit to homeowners, the question on the minds of many real estate watchers is how much of an impact these “triggered” mortgages will have on the softening housing market. Higher monthly payments could push some owners, especially investor-owners, to put their properties on the market, adding to an already growing supply of homes.
“We don't know yet what that's going to look like, but introducing somewhat distressed supply into a weak resale market is not ideal,” Rabidoux said.
Ron Butler, founder of Butler Mortgage, sees the greatest pressure coming from the private lender segment of the mortgage market. Private lenders offer less creditworthy borrowers mortgages at much higher rates, and Butler expects some mortgages will be “called” as rates rise even further. That is, borrowers will be asked to pay off the balance immediately.
That could lead to forced sales in the housing market, and further downward pressure on prices. But the impact should be fairly limited, as private lenders amount to a very small share of Canada’s mortgages, around 1% as of 2019.
However, this private lender market is very concentrated in Ontario and British Columbia, with about 85% of private loans in those two provinces. So they stand to see more impact from distressed sales than other places.
It’s not only a question of how high interest rates will go, but how long they will stay elevated, Butler said.
“The longer rates are high the more pressure builds when mortgages renew at higher payments,” he wrote in an email exchange.
“The biggest effects are likely months from now if high rates stay in place. Then prices could reduce further.”
For investor-owners, the current surge in rental rates is “very helpful,” Butler added.
Also helping things is fast growth in wages, which were up 5.2% year on year in July, according to Statistics Canada. While that doesn’t beat overall inflation, which came in at 7.6% in July, it does help with mortgage payments.
But that high rate of inflation is precisely why borrowers shouldn’t expect last year’s rock-bottom interest rates to come back anytime soon, Rabidoux said.
“There's a good chance we're in an era of structurally higher inflation and central banks won't be going back to zero for a very long time.”