Homeowners with variable-rate mortgages face difficulties as interest rates rise and home prices fall, warns Bank of Canada

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Houses on Sherman Brock Circle in Newmarket, Ontario. on March 30, 2021.Fred Lum/The Globe and the Mail

Canada’s financial system should be able to weather a period of increased stress, but many recent homebuyers could experience a “painful” crunch as interest rates continue to rise, the Bank of Canada’s second-in-command said Tuesday. .

In a speech in Ottawa, Senior Lieutenant Governor Carolyn Rogers said long-standing vulnerabilities in Canada’s housing market have been worsened by the COVID-19 pandemic as home prices soar and buyers increasingly rely on variable-rate mortgages, which are linked to central bank benchmark loans. Speed.

Now that interest rates are rising and home prices are falling, many of these homebuyers are experiencing a nasty adjustment, Ms. Rogers said.

The most common variable rate product has fixed monthly payments. With each interest rate increase, more of the borrower’s monthly payment goes toward interest. However, when the monthly payment no longer covers the principal, the borrower hits what is known as the trigger rate and their monthly payment increases. In some cases, the lender allows the borrower to transfer the interest to the principal, increasing the size of the mortgage.

Fifty percent of these variable-rate mortgage holders have already reached their trigger rate, according to estimates in a new Bank of Canada research paper published Tuesday. That share will increase to 65 percent by the middle of next year as the central bank continues to raise interest rates to control inflation.

What is your mortgage trigger rate? This calculator helps you estimate it

“The bottom line is that mortgage costs for some Canadians have already risen, and are likely to rise for others over time, making home ownership more expensive.” said Mrs. Rogers.

According to the Bank of Canada, around 670,000 variable-rate mortgages have been issued since the start of the pandemic. Adjustable-rate mortgages accounted for about 50 percent of all mortgages issued since mid-2021, compared with an average of 20 percent in the years before the pandemic.

“This is not a huge portion of homes, but it is larger than it would have been based on historical trends,” Ms. Rogers said.

Borrowers have sought out variable-rate products because borrowing costs have generally been cheaper than fixed-rate mortgages. Part of the motivation was that federal banking rules require borrowers to show they can make their monthly mortgage payments at an interest rate at least two percentage points higher than their actual mortgage contract.

Bellagio Crescent houses in Mississauga, Ontario.Fred Lum/The Globe and the Mail

Troubles in the mortgage market can infect the broader financial system if borrowers default. Ms Rogers said that Canada’s banking system is in a good position to handle potential shocks, thanks to reforms following the 2008-09 financial crisis that increased capital and liquidity requirements for lenders and strengthened credit testing. mortgage stress.

In addition, the central bank “does not expect a severe economic downturn with the kind of large job losses typical of past recessions,” he said.

But tens of thousands of homeowners will be affected as interest rates continue to rise. The Bank of Canada is expected to raise interest rates again on December 7, either by a quarter point or a half point. Financial markets expect the bank’s benchmark interest rate to reach 4.25% in early 2023, up from 3.75% today.

The research paper noted that over the past decade, few borrowers have had to deal with the trigger rate because interest rates have been relatively low since the global financial crisis.

“But with rapid increases in the Bank of Canada policy interest rate since March 2022, variable-rate mortgage borrowers have historically faced large interest rate increases that make reaching their trigger rate difficult. a significant possibility,” said the article written by Stephen. Murchison, Advisor to the Governor, and economist Maria teNyenhuis.

Major lenders have downplayed the trigger rate and have repeatedly said that only a small subset of their borrowers are at risk of hitting this threshold. The research paper is the first time the central bank has attempted to quantify the effects of higher interest rates on variable-rate mortgage holders.

The researchers estimated that these mortgages account for 13 percent of all outstanding mortgages. They said this estimate does not account for borrowers who proactively make a balloon payment or take other steps to avoid hitting their trigger rate.

Outstanding mortgages include fixed-rate mortgages for which the monthly payment and interest cost remain the same for the life of the loan. It also includes variable rate mortgages with variable payments whose monthly amount changes with fluctuations in the central bank’s benchmark interest rate.

The Bank of Canada paper found that variable-rate mortgages now account for about a third of all outstanding mortgage debt. That compares to a fifth in 2019.

The central bank is raising interest rates to slow the growth of consumer prices. He doesn’t specifically target home prices, but Ms Rogers suggested that the bank is only too happy to see those prices fall. Nationwide, home prices are down about 10 percent from the February peak.

“We need lower house prices to restore balance to Canada’s housing market and make home ownership more affordable for more Canadians,” said Ms. Rogers.

So far, however, rising interest rates have made housing less affordable, with rate increases more than offsetting home price declines. Royal Bank of Canada’s national aggregate affordability measure hit its worst ever level in September.

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