Number of variable-rate mortgage holders hitting trigger rate to rise to 65 per cent next year, BOC warns

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Home on Sherman Brock Circle in Newmarket, Ont. on March 30, 2021.Fred Lum/The Globe and Mail

Canada’s financial system should be able to weather a period of heightened stress, but many recent home buyers may feel a “painful” squeeze as interest rates rise, the Bank of Canada’s second-in-command said Tuesday.

In a speech in Ottawa, Senior Deputy Governor Caroline Rogers said chronic weaknesses in Canada’s housing market have been worsened by the COVID-19 pandemic as home prices rise and buyers increasingly rely on variable-rate mortgages, which are linked to the central bank’s benchmark lending. rate

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

The most common variable-rate products have 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 is in what is known as a 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 their trigger rate, estimates a new Bank of Canada research paper published Tuesday. That share will rise to 65 percent by the middle of next year as the central bank raises interest rates to curb inflation.

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

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

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

“It’s not a large portion of the household, but it’s larger than it should be based on historical trends,” Ms. Rogers said.

Borrowers seek out variable-rate products because borrowing costs are generally 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 original mortgage contract.

Home of Bellagio Crescent in Mississauga, Ont.Fred Lum/The Globe and Mail

Problems in the mortgage market can infect the broader financial system when borrowers default on 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 strengthened mortgage stress tests.

Moreover, the central bank “does not expect a severe economic downturn with large job losses like in past recessions,” he said.

But thousands of homeowners will be pinched 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 percent in early 2023, up from 3.75 percent today.

The paper notes that over the past decade, few borrowers have faced trigger rates because interest rates have remained relatively low since the global financial crisis.

“But with the Bank of Canada’s policy interest rate rising rapidly from March 2022, variable-rate mortgage borrowers face historically large interest rate increases that create a significant possibility that they will reach the trigger rate,” said the paper authored by Stephen. Murchison, adviser to the governor and economist Maria Tenenhuis.

Major lenders have lowered trigger rates and repeatedly said a small subset of their borrowers risk reaching this threshold. The paper is the first to attempt to measure the impact of higher interest rates on central bank variable-rate mortgage holders.

Researchers estimate that these mortgages account for 13 percent of all outstanding mortgages They said this estimate does not account for borrowers actively taking a single payment or other steps to avoid reaching their trigger rate.

Fixed-rate mortgages include fixed-rate mortgages for which monthly payments and interest costs remain the same for the life of the loan. This includes variable-rate mortgages with variable payments for which the monthly amount changes with fluctuations in the central bank’s benchmark interest rate.

Variable-rate mortgages now account for nearly one-third of all outstanding mortgage loans, the Bank of Canada paper found. This compares with one-fifth in 2019.

The central bank is raising interest rates to slow the rise in consumer prices. It did not specifically target house prices, but Ms Rogers suggested the bank was quite 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 restore balance to Canada’s housing market and make home ownership more affordable for more Canadians,” Ms. Rogers said.

So far, however, rising interest rates have actually made homes less affordable, with rates increasing more than home values ​​falling. The Royal Bank of Canada’s national overall purchasing power measure hit its worst ever level in September.

Number of variable-rate mortgage holders hitting trigger rate to rise to 65 per cent next year, BOC warns

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