Rising interest rates tend not to be welcome news to most people, especially not to Canadians who have borrowed heavily in order to buy a home in the country's red-hot real estate markets over the past few years.
The latest rate increase is expected to come Wednesday and the central bank is expected to hike its key lending rate by as much as 75 basis points in order to combat runaway inflation.
There is a good reason why that might sound scary to many people, especially those who have recently purchased a home on a variable rate mortgage.
According to a report released this week by the Canada Mortgage and Housing Corporation (CMHC), more than half of all mortgages taken out in the second half of 2021 were variable rate mortgages, an anomaly not seen in the last 10 years in a country where people tend to strongly favour fixed rates.
Driven by steep discounts on variable rates, that trend continued for the first two months of 2022 as well, with more than 55 per cent of mortgages being taken out on a variable rate.
What's more, mortgage growth over the last 12 months ramped up to a level not seen since 2008, according to CMHC.
“So when we look at 2021, and even in early 2022, mortgage debt not only has been increasing but it actually accelerated. So we're talking about close to 10 per cent increase in mortgage debt compared to the previous year,” CMHC Senior Economist Tania Bourassa-Ochoa told CP24.com in an interview. “So Canadians have high levels of indebtedness, and that is something that we've been monitoring very closely.
Obviously, it’s a potential source of vulnerability to the housing system. So definitely something that we're looking at very closely.”
Bourassa-Ochoa said the mortgages that have been taken out are also larger as people spend more to keep up with rising housing prices.
MORTGAGES LAST PLACE CANADIANS WANT TO SLIP
She said those with variable rate mortgages will be the first to feel the pinch when rates rise, but added that “there’s still some nuances" to the situation.
For example, those who have opted to regularly pay more than the minimum each month might not notice an increase in their payments, though they will be paying off less capital each month than they were before.
Mortgage delinquencies — the proportion of mortgage holders that haven't made their payments for 90 days or more — are also still at record low levels.
While Bourassa-Ochoa acknowledged that mortgage delinquencies are a "delayed indicator" of debt troubles, she said mortgages are likely not the first place that debt problems will emerge.
“So I think in the next couple of months, in the next couple of quarters, it's going to be interesting to look at delinquencies on other credit products, like credit cards, auto loans, personal loans.”
Those, she said, will likely be the initial indicators if Canadians do start feeling the squeeze from rising interest rates.
“Typically, those are the loans that are going to be delinquent first, if I could put it that way. So that could be an early indication prior to mortgage payments,” she said. “Canadians will try to make every way possible to make their mortgage payments on time.”
The latest CMHC report also points out that the recent acceleration in mortgage borrowing was due to increases in uninsured mortgages for both property purchases and refinancing. That's important because it indicates that most of the new debt is being taken out by individuals who are not over-leveraged (mortgage insurance is mandatory if one puts down less than 20 per cent of the purchase price on a property).
And while the acceleration in borrowing is at the highest level since 2008 when the subprime mortgage crisis in the U.S. triggered a recession, Bourassa-Ochoa points out that there are “a variety of different measures and tools” that were put in place to ensure stability in the Canadian housing system.
She points to a “stress test” implemented for borrowers in 2018 to ensure that they can withstand an additional two per cent increase in rates. Canada also has full recourse loans, meaning that lenders can seize assets in a default situation if the sale of a home doesn’t cover the debt, making it less attractive for borrowers to walk away from their homes if they get in trouble.
And despite the recent craze for variable rates, Bourassa-Ochoa points out that the majority of mortgages in Canada are still five-year fixed products and borrowers will therefore only face higher rates when it comes time to renew.
That sentiment is echoed by RBC Chief Economist Nathan Janzen.
Speaking with CP24 this week, he said that the expected rate increase Wednesday would still bring the bank’s overnight rate to just 2.25 per cent, still a historically low rate.
“We do expect more hikes to come. We have another 100 basis points over the next couple of meetings to get up to a (anticipated) 3.25 per cent overnight rate, so that will flow through the household borrowing costs,” Janzen said. “Some variable mortgage rate payments reset immediately, effectively once the Bank of Canada changes interest rates, but for a lot of other mortgage holders it takes time. They only reset when you need to renew. So that's another reason why we expect the impact on household purchasing power to be delayed and see more of an impact into 2023.”
RBC, the country’s largest mortgage lender, is forecasting a mild recession for 2023, along with a 10 per cent drop in housing prices in the year ahead.
This week, the Toronto Regional Real Estate Board said that June sales were down 41 per cent compared to the same month a year ago, indicating that rising rates and uncertainty about the economy may already be cooling housing markets.
‘THE MILLION DOLLAR QUESTION’
Mortgage brokers are definitely registering some of that anxiety from potential clients.
“I guess, the million dollar question we get asked right away, right off the top, you know, is where interest rates are going,” said Anthony Contento, owner and broker at Toronto’s Sherwood Mortgage Group.
“If we all knew that, if we had that crystal ball we'd all be millionaires,”
He said there is “a lot of the uncertainty” when prospective borrowers come to him these days.
“There's a lot of uncertainty whether or not they should be locking it in or riding the variable rate. So I think the consumer’s a little bit intimidated for one and two, really uncertain as to where to go,” he says. “The reality of it is a lot of them are renewing at whatever is being offered them by the banks because should they want to go elsewhere, they’re needing to qualify all over again.”
He said even at historically low interest rates, the stress test makes it difficult for some people who are renewing to re-qualify with new lenders.
“For sure there's a panic button right now that many are pushing not knowing where to go,” he said. “And there's a lot of folks right now that are coming up to maturity where once they were paying 2.2 or 1.9 on a fixed rate three, four years ago and now you know they're looking at 4.99. That certainly changes the landscape altogether as to what they can afford.
“So it's certainly a little bit of a grey cloud right now hovering over the consumer, right and their decision as to what they should be doing.”
He pointed out that variable mortgages may still be attractive to many people who are willing to weather a few increases in exchange for a discounted rate, but he said ultimately everyone needs to draw a clear assessment of their own financial picture before deciding what works best for them.
“The most prudent thing to do would probably be sit down with your partner or if you're on your own and just go through your whole budget and where you're at,” Contento says. “it'll give you a better indication as to what your comfort level is going to be, where your risks lie as far as whether you're wanting to sort of play that variable game or stay in the fixed. Once you've worked out and you've drawn that line down on paper and the pros and cons of either a fixed or a variable, I think only the consumer themselves know what they can afford.”
The message from Contento and other lenders for the time being is to do your homework before taking out a loan or refinancing and make sure that it fits with your financial goals, even if rates do continue to increase somewhat.
“We know that that buying a home is one of the largest purchases that Canadians will ever make. So it's really important to do your research,” says Andrea Metrick, Senior Director, Home Equity Finance at RBC. “It's really important to look at the right tools, have the right conversations around how purchasing a home at this time or you know when you're thinking about buying a home how that fits into your overall financial plan.”
She said homeowners need to think about the one-time costs, ongoing costs and possible emergency costs associated with homeownership when making their decision about buying and borrowing.
“The homeowners or prospective homeowners need to really be thinking about, you know, what are the trade-offs that I might need to make with the factors that I need to be considering and is now the right time to buy within those factors for my personal situation.”
While it’s difficult to predict exactly what will happen beyond the next couple of quarters, Bourassa-Ochoa said industry and government will be watching closely.
“You know, the thing that we're really looking at keeping a close eye on is definitely the level of indebtedness.
“In the context of rising and rapidly rising interest rates, yeah, for sure inevitably, that's going to put some pressure on some households and especially the households that are more largely indebted.”
