Roughly three quarters of all variable mortgages across Canada have hit their trigger rate, but financial institutions' approach to dealing with this poses a question of whether they're creating a "ticking time bomb," a new report from Desjardins lays out.

As the Bank of Canada (BoC) kept on with its aggressive rate hike cycle in 2022 and 2023, more and more fixed-payment variable-rate mortgage holders found themselves hitting their trigger rate -- the point at which a borrower's payment is no longer enough to cover the interest. Typically, a bank would then raise a borrower's payments to fill in the gap, but that doesn't seem to be the case right now, Desjardins says.

"Lenders are making surprising accommodations for troubled borrowers," the report reads, noting that many borrowers are not being asked to make additional payments.

"But the money owed still needs to be paid back," the report says. "The question is whether this is a ticking time bomb with the detonation set for a couple of years in the future."

Instead of higher payments, a number of financial institutions are adding the owed interest to the outstanding principal amount, with some saying they'll allow the principal to grow to 105% of the original loan value before requiring any additional payments.

By Desjardin's calculations, even if the BoC policy rate were to remain at its current level all the way through 2024, no mortgages would breach that threshold. "In fact, the Bank of Canada would have to raise rates to almost 7% by July and leave them unchanged until the end of 2024 for the worst‑off borrowers to owe more than 105% of the original loan value before renewal," the report says.

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A more immediate concern, however, is the growing number of mortgages that now have amortization periods of 30 years of more -- something the Office of the Superintendent of Financial Institutions (OSFI) says its watching closely.

"Recently, the regulator stated that it’s considering whether the capital that financial institutions hold against these mortgages is sufficient," Desjardins says. "That comes on top of the tougher lending requirements OSFI proposed earlier in the year. Furthermore, the regulator has recognized how quickly bank runs can happen in this new digital age and has said it is intensifying its focus on liquidity."

As for who will be most affected come renewal time, Desjardins points to first-time buyers, who generally have less equity in their homes and lower incomes. Fixed-rate mortgages taken out five years ago "have already been renewing with materially higher payments over the past year."

"Roughly half of the homes sold in any given year are to first‑time homebuyers, so the group renewing for the first time is not a small one," the report reads.

Desjardins is expecting the BoC to begin cutting rates around the new year, ending 2024 at 2.5%. Even still, their projections show some sticker shock ahead for both fixed- and variable-rate borrowers.

Fixed-rate borrowers renewing their mortgages in 2025 and 2026 will see their payments rise roughly 15%, Desjardins projects. According to the report, "Many households will likely be facing such a shock since fixed‑rate mortgage originations with five‑year terms surged in 2020."

For variable-rate holders, to remain on the original amortization schedule, they would see payments increase more than 30% at renewal time. This could be offset by making a lump sum payment at renewal, but would require a lump sum payment of roughly 20% of the original loan value to keep the payments unchanged.

"To put that in perspective, a first-time homebuyer who purchased a house in 2018 for $1,000,000 and put $200,000 down would need to put up another $160,000 to keep their monthly mortgage payment steady," the report lays out.

Unsurprisingly, variable-rate holders who haven't been able to pay off much of the principal will be hit particularly hard.

"To keep the monthly payment the same as before without making any lump sum payments, the amortization would have to extend to almost 40 years at renewal in some cases," the report reads. "The Canadian Housing and Mortgage Corporation has stated that it has no plans to extend the maximum 25‑year amortization for insured mortgages. For uninsured mortgages, the federal government has stated that, when extending the amortization for troubled borrowers, the commercial banks must ensure the amortization period remains 'reasonable.' There’s been no additional guidance about what’s 'reasonable' and what’s not, but anything above 35 years doesn’t seem likely to be eligible.