Canada’s financial system should be able to weather a period of increased stress, but many recent homebuyers could experience a “painful” squeeze as interest rates continue to rise, the second head of the Bank of Canada said Tuesday. In a speech in Ottawa, Senior Deputy Governor Carolyn Rogers said long-standing vulnerabilities in Canada’s housing market were exacerbated by the COVID-19 pandemic as home prices soared and buyers increasingly relied on variable-rate mortgages, which are linked to the reference lending of the central bank. price. Now that interest rates are rising and home prices are falling, many of these homebuyers are experiencing a rough adjustment, Ms. Rogers said. The most common variable rate product has fixed monthly payments. With each increase in interest rates, a larger portion of the borrower’s monthly payment goes to interest. However, when the monthly payment no longer covers any 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, which increases the size of the mortgage. Fifty percent of those variable-rate mortgage holders have already reached the trigger rate, according to estimates from a new Bank of Canada research paper published Tuesday. That share will rise to 65% by the middle of next year as the central bank continues to raise interest rates to curb inflation. What is your mortgage trigger rate? This calculator helps you figure it out “The bottom line is that mortgage costs for some Canadians have already risen and will likely rise for others over time, making home ownership more expensive.” said Ms. Rogers. About 670,000 variable-rate mortgages have been issued since the start of the pandemic, according to the Bank of Canada. Variable rate mortgages accounted for about 50 percent of all mortgages issued as of mid-2021, compared to an average of 20 percent in the years before the pandemic. “This is not a large share of households, but it is larger than would be based on historical trends,” Ms Rogers said. Borrowers have sought out variable rate products because borrowing costs have typically been cheaper than fixed rate mortgages. Part of the motivation was that federal banking rules require borrowers to prove they can make their monthly mortgage payments at an interest rate at least two percentage points higher than their actual mortgage contract. Homes Bellagio Crescent in Mississauga, Ont. Fred Lum/the Globe and Mail Problems in the mortgage market can contaminate the wider financial system if borrowers default on their payments. Ms. Rogers said Canada’s banking system is well-positioned to handle potential shocks, thanks to reforms after the 2008-09 financial crisis that increased capital and liquidity requirements for lenders and tightened stress tests for mortgages. In addition, the central bank “does not expect a severe economic downturn with the kind of large job losses that have characterized past recessions,” he said. But tens of thousands of homeowners will be stung as interest rates continue to rise. The Bank of Canada is widely expected to raise interest rates again on December 7, either by a quarter or half a point. Financial markets expect the bank’s benchmark rate to reach 4.25 percent by early 2023, up from 3.75 percent today. The research paper noted that over the past decade, few borrowers have had to face the trigger rate because interest rates have been relatively low since the global financial crisis. “But with the Bank of Canada’s rapid increases in the policy rate starting in March 2022, variable rate mortgage borrowers have historically faced large rate increases that make hitting their trigger rate a significant possibility,” Stephen’s paper said . Murchison, Advisor to the Governor, and economist Maria teNyenhuis. The big lenders have downplayed the trigger rate and have repeatedly said only a small subset of their borrowers are at risk of reaching that limit. The research paper is the first time the central bank has attempted to quantify the impact of higher interest rates on variable rate mortgage holders. Researchers estimated that these mortgages represent 13 percent of all mortgages outstanding. They said that estimate doesn’t take into account borrowers who preemptively make a lump sum payment or take other steps to avoid hitting the 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 where the 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. This compares with one in five in 2019. The central bank raises interest rates to slow the rise in consumer prices. It is not specifically targeting house prices, but Ms Rogers suggested the bank is more than happy to see those prices fall. Nationally, home prices are down about 10 percent from their peak in February. “We need lower house prices to rebalance Canada’s housing market and make home ownership more affordable for more Canadians,” said Ms. Rogers. So far, however, rising interest rates have made homes less affordable, with rate increases more than offsetting falling home prices. Royal Bank of Canada’s national affordability measure hit its worst level in September.
