The number of variable-rate, fixed-payment mortgages that reached their so-called "trigger" has spiked recently
The rising-rate environment of 2022 has presented a series of challenges for Canadian borrowers – not least those on variable rates, many of whom have seen their mortgage ticking closer to its trigger point.
That level, which means a borrower’s payments are only covering interest and not going toward principal, has already been met by a growing number of Canadians, according to the Bank of Canada, which indicated about 13% of mortgage holders across the country were impacted by the end of October.
That includes 50% of variable-rate mortgage holders with fixed payments, the central bank said, with the figure expected to hit 65% by the middle of next year if interest rates continue moving upwards.
While that’s a cause for some concern, one prominent observer told Canadian Mortgage Professional it was also important to focus on the challenges faced by other borrowers on variable rates – namely, those with variable rather than fixed payments.
“There’s a group of Canadians [for whom] there’s no option, their payments have simply gone up,” said James Laird (pictured top), co-CEO and co-founder of RateHub.ca. “And before [the Bank of Canada’s latest announcement], we calculated those payments are up about 50% this year.
“So that group is the leading edge of feeling the brunt of this year’s rate increases – variable rates with variable payments.”
What’s the difference between borrowers on fixed and variable payments?
Other consumers on variable rates may have seen their fixed payments jump upwards – depending on the lender and loan-to-value – but the change is likely to be relatively modest, Laird said, compared with those borrowers whose payment amount always increases when rates go up.
“It all depends on the lender, but we believe with all or most lenders, the worst that you have to do is cover your interest payment,” he said, “which means that your payment is gong up a little bit – but not nearly the same degree as someone with a variable rate and a variable payment.
“And many don’t have to do anything. Many lenders, if the loan-to-value is favourable, they let the consumer do something or not. They say, ‘Look, you’re in a reverse amortization situation where you’re not covering your interest. Let’s talk about that. But you don’t have to do anything – we’ll let you continue in this environment.’”
Seeing how those variable-payment, variable-rate customers fare with their higher payments will be a key indicator of the health of the market in 2023, he added.
“The group we should be looking at first is the variable rate [customers] with variable payments – see how that group’s doing, with their payments that are 50% higher, see if there’s any uptick in default,” he said, “because they’re sort of the leading indicator of the whole market… the whole market will have to renew within five years and absorb whatever the rates are at the time, which could be lower than they are right now.”
What is the Bank of Canada doing about it?
Bank of Canada analysts Stephen Murchison and Maria teNyenhuis noted that the central bank holds regular conversations with commercial banks, “and notes that they are working proactively with their customers who have variable-rate mortgages with fixed payments to determine appropriate solutions on a case-by-case basis.”
Indeed, as Laird indicated, the Bank said that it estimated the median payment increase would have been about 5% at most for those mortgages that had already reached their trigger rate, as the typical mortgage was triggered at a median interest rate of 4.8%, “only slightly below the rates observed at the end of October 2022.”
Ultimately, while the Bank believes that a high share of variable-rate, fixed-payment mortgages are set to reach their trigger rate by next year, it stressed that that doesn’t necessarily mean all those households will then be required to increase their regular payments.
“Some borrowers may have made prepayments on their mortgage, refinanced their mortgage, switched to a fixed-rate mortgage, or applied other changes since origination that would prevent a payment increase,” it said.
Households that took out those mortgage types before the arrival of COVID-19 in Canada are also likely to have paid down additional principal relative to their amortization schedule, the Bank said, due to the dramatic decrease in variable rates after the outbreak of the pandemic.
“As a result, our estimates should be interpreted as an upper bound of the impact of trigger rates on households.”
What are you keeping top of mind for borrowers whose mortgages are nearing or at their trigger point? Let us know in the comments section below.