The next Bank of Canada announcement is just hours away, and while economists are split on just how large a hike is to come, borrowers are already feeling the pressure.
Many variable-rate holders have been on the receiving end of courtesy calls from their bank as of late, informing them that they’ve reached, or are approaching, their trigger rate: the point at which their monthly payments stop covering both interest and principal, and go toward interest only.
However, with interest rates on the rise again, more borrowers will be at risk of hitting their trigger point, a grim milestone when -- as a result of only paying that interest -- their principal debt has crept back up to its original level, or higher. That means any progress that they’ve made on paying down their mortgage -- and building equity -- has been effectively wiped out.
When that happens, the phone calls are no longer a nicety, says Leah Zlatkin, mortgage broker and expert at LowestRates.ca.
“The bank is going to give you a courtesy call for your trigger rate,” she tells STOREYS. “They’re going to say, ‘Hey, we just wanted to let you know that you are now paying all interest and no principal, and we’re deferring it for you. If you want, you can increase your payment now.’
You can choose to say, ‘No, I don’t want to do this, I get x number of dollars per week and I need to be able to buy my Netflix and I need to be able to buy my groceries.' When you hit the trigger point, it is no longer the courtesy call. It is the bank saying, ‘We’re changing your payment amount, you’ve hit the contractual obligation… We’re sorry that you have to buy groceries, but guess what -- you owe us another $400 a month.’”
Banks may also offer borrowers hitting their trigger point options such as locking into their posted fixed rate, adjusting their amortization period higher, or paying a lump sum in order to restore monthly payments to both principal and interest.
Zlatkin foresees more affected borrowers being served this ultimatum in the coming weeks and months, as the Bank of Canada rounds out its hiking cycle.
That so many borrowers are being triggered is a unique phenomenon that reflects today’s economic climate; it’s been brought about by the rapid increase in mortgage rates that has occurred over a short period of time.
Since March of this year, when the Bank of Canada made its first hike in response to soaring inflation, its trend-setting Overnight Lending Rate has increased by 3%, from the pandemic low of 0.25% to 3.25% today. That’s the fastest pace since the 90s, and economists anticipate another added percentage before it’s through; tomorrow’s announcement could bring the rate to a ballpark of 3.75 - 4.5%.
Anyone who purchased a home in the last two years -- especially in pandemic-inflated markets -- and opted for the day’s record-low variable rate, is feeling the squeeze today.
James Laird, Co-CEO of Ratehub.ca and President of CanWise mortgage lender, says it’s the first time in his 15-year career that borrowing costs have risen so sharply and triggers have become so prevalent.
“You’d have to look back into the 90s and the 80s at what happened to variable rates during these sort of fairly rare sharp rate increases, because that would really only be the other time that rates would have moved this much within a five-year period -- and in this case, it’s within a six-month period,” he says.
“It’s a pretty unique and rare phenomenon that can only be caused by going from record lows like we were -- and a lot of people got their mortgage at record lows, so their baseline is extremely low -- followed by a very unusual rate increase.”
However, both mortgage experts argue that while it’s a stressful time to be a variable borrower, it hasn’t materially changed the risk profile for that mortgage type. From a historical perspective, variable holders almost always pay less on their mortgage overall -- if they can ride out the temporary volatility.
“There’s an argument for both variable and fixed-rate mortgages, and I’m one of the big huge proponents of a variable-rate mortgage; 19 out of 20 times, in the last 15 years, it has been the right choice to go variable,” says Zlatkin.
“A broken clock is still right two times a day and so in those small circumstances, which we’re living through right now, some people who got their fixed-rate mortgages during the pandemic at 1.79% -- those people absolutely lucked out compared to variable-rate mortgages. However, those people still have to live in that house for five years, and if that is not the case for you, you may have not lucked out. But for people who got variable-rate mortgages, absolutely right now feels very stressful.”
Those who are on the receiving end of trigger point phone calls will find themselves in good company; there was ferocious appetite for variable mortgages over the last two years, as rates were kept at pandemic record lows while housing prices spiked.
According to analysis from the Canada Mortgage and Housing Corporation, the market share of variable rose to more than 50% this year. Meanwhile, the Bank of Canada has rung alarm bells over the size and risk profile of Canadians’ mortgage debt, calling it a key economic vulnerability in their summer Financial Systems Review.
“There would be lower systemic risk if everyone had taken out a fixed-rate mortgage in the last five years, I think we know that,” says Laird. The stress test has never looked so brilliant as it does right now. When they came up with the stress test, they definitely did not anticipate this, but it’s proven to be a very important policy.”
However, he adds, Canadian mortgage borrowers have been historically dedicated to paying down their debt, even if it means making tough financial decisions for the household. In fact, from a global perspective, Canadian mortgage defaults come in lower than other G7 countries.
While acknowledging the financial strain today’s rate increases are having on households, he adds that those who don’t experience changes to their income profile should be able to handle their payments at today’s elevated rates.
“It might mean very difficult decisions -- music lessons or a trip -- but what we know is anyone who got a variable rate in the last five years did pass the stress test at rates similar to what they’re paying right now,” he says.
"So as long as we haven’t gone from two incomes to one, or there hasn’t been a health issue -- and again, they might have to cut back on certain things -- but the income should be there to make these mortgage payments and not default.”