The Bank of Canada has highlighted a big trend coming down the line
Interest rate hikes may be on hold for now – but a significant trend in the coming months will see many current homeowners face higher borrowing costs as their mortgage comes up for renewal.
The Bank of Canada’s latest Monetary Policy Report, which accompanied its last rate decision on April 12, indicated that the share of income spent on interest payments would continue to rise in the near future because of the much higher rates currently at play in the market.
If its policy rate continues to follow the path expected by financial markets as of April 4, “the effective interest rate on variable-rate mortgages peaks in the first half of 2023,” the Bank said. “Meanwhile, the effective interest rate on fixed-rate mortgages rises through 2024 as mortgages with low interest rates reach the end of their term and are replaced by new (or renewed) mortgages with higher rates.”
In a scenario constructed to assess the possible impact of higher renewal rates on homebuyers, the central bank noted that that the interest portion of household mortgage payments could peak at about 5.5% of disposable income by the third quarter of income – an outcome that would represent the highest level since the late 1990s.
“Borrowers may be able to mitigate some of these increased costs,” the Bank noted. “However, their budgets will continue to feel the strain of these costs over the coming quarters.”
Is a shock set to hit the market where renewals are concerned?
Dominique Lapointe (pictured top), director of macro strategy at Manulife Investment Management, told Canadian Mortgage Professional that while the impact of that trend had not yet become apparent, it could pose a big challenge in the coming months.
“Clearly, there’s a shock coming and we’ve only seen the beginning of this,” he said. “We’ve seen transactions plummet, but we haven’t seen a lot of distress, if any. Unfortunately, the big shock’s coming in the spring, summer, this fall, when we’ll have more people [needing] to refinance at a higher rate.”
With recent reports having indicated that some banks are allowing variable-rate clients to put negative amortizations on their homes to handle higher borrowing costs, that will also exacerbate the problem, Lapointe said.
“If rates are being left at these levels and going to next year, then people that have those variable mortgage rates that now are paying negative amortization of their house, when they renew, the banks will have to re-amortize the mortgage over the original term, which is probably 25 years, 30 years,” he said.
The Office of the Superintendent of Financial Institutions (OSFI), Canada’s financial services watchdog, spoke out against mortgage payment extensions being offered to borrowers, describing those as short-term solutions that will only exacerbate consumers’ debt struggles in the long term.
Canada’s banking regulator, the OSFI, has warned that the mortgage payment extensions currently offered to borrowers in the country are short-term solutions that will leave them in debt for longer periods.https://t.co/yusDsq8Ofg— Canadian Mortgage Professional Magazine (@CMPmagazine) April 17, 2023
Tolga Yalkin, OSFI’s assistant superintendent, told a conference held by the C.D. Howe Institute last week that a larger number of highly leveraged borrowers had increased the risk of further defaults and broad economic volatility.
How can borrowers protect themselves against higher costs?
The Bank of Canada’s Monetary Policy Report said borrowers could explore multiple courses of action to mitigate increases in interest costs including paying off some of their existing balance owed or making payments on their principal more quickly.
The central bank actually recommended extending the amortization period as a possible option for households in a financial pinch, it said, while also noting the potential for new mortgage term preferences.
“Recently, as short-term interest rates have increased, new borrowers have shifted away from variable- and five-year fixed-rate mortgages toward fixed-rate mortgages with terms between one and four years,” it said. “This suggests that many borrowers are assuming that mortgage rates will be lower in a few years.”
As for the potential for variable rates to climb again in 2023? Lapointe said that the Bank was likely to carefully weigh whether more hikes are needed if economic trends don’t develop as expected – although the probable landing point of the central bank’s policy rate remains the same.
“If the data for any reason continues to suppress the upside, either on the growth side or the inflation side, they will feel compelled to hike further. I think that’s what we need to factor in,” he said.
“But that being said, our outlook is weaker than what they have. So for us, the higher they go and the quicker they go, also the faster and the deeper they’ll have to cut, either later this year or early next year. So it will end up at the same point, but they might feel compelled to hike further.”
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