Homeowners with variable rate mortgages face tough pressure as interest rates rise and home prices fall, Bank of Canada warns – The Globe and Mail Pipa News

Homeowners with variable rate mortgages face tough pressure as interest rates rise and home prices fall, Bank of Canada warns – The Globe and Mail

Houses 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 homebuyers could experience “painful” pressure if interest rates continue to rise, the Bank of Canada’s second-in-command said Tuesday.

Speaking in Ottawa, Deputy Governor Carolyn Rogers said long-standing vulnerabilities in Canada’s housing market have been exacerbated by the COVID-19 pandemic as home prices soared and buyers increasingly relied on variable-rate mortgages, which are tied to the central bank benchmark lending. rate.

With interest rates rising and home prices falling, many of these homebuyers are experiencing a nasty 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 toward interest. However, when the monthly payment no longer covers any principal, the borrower reaches what is known as a trigger rate and their monthly payment rises. In some cases, the lender allows the borrower to shift the interest to the principal, making the mortgage larger.

Fifty percent of these floating-rate mortgage holders have already hit their trigger rate, according to estimates from a new research report from the Bank of Canada released Tuesday. That share will rise to 65 percent by the middle of next year as the central bank continues to raise interest rates to contain inflation.

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“The bottom line is that mortgage costs have already risen for some Canadians, and for others they are likely to rise over time, making home ownership more expensive.” said Mrs. 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 since 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 it would have been based on historical trends,” Ms Rogers said.

Borrowers have sought out variable-rate products because the cost of financing is typically 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 infect the wider financial system if borrowers default. Ms Rogers said the Canadian banking system is well positioned to handle potential shocks, thanks to post-financial crisis reforms of 2008-2009 that increased capital and liquidity requirements for lenders and strengthened mortgage stress tests.

In addition, the central bank “does not expect a severe economic downturn with the kind of large job losses that have characterized past recessions,” she said.

But tens of thousands of homeowners will be squeezed if interest rates continue to rise. The Bank of Canada is widely expected to raise interest rates again on December 7, by a quarter or half a point. The financial markets expect the bank’s benchmark interest rate to reach 4.25 percent in early 2023, compared to the current 3.75 percent.

The research paper noted that few borrowers had to deal with the trigger rate over the past decade because interest rates had been relatively low since the global financial crisis.

“But with the Bank of Canada’s rapid hikes in policy rates since March 2022, floating rate mortgage borrowers have faced historically large interest rate hikes that make reaching their trigger rate a significant possibility,” said the paper authored by Stephen Murchison, advisor to the governor, and economist Maria teNyenhuis.

Major lenders have downplayed the trigger rate, repeatedly saying that only a small fraction of their borrowers are at risk of reaching this threshold. The research paper is the first time the central bank has attempted to quantify the effects of higher interest rates on floating-rate mortgage holders.

The researchers estimate that these mortgages make up 13 percent of all outstanding mortgages. They said this estimate does not account for borrowers who proactively pay a lump sum or take other steps to avoid reaching their trigger rate.

Outstanding mortgages include mortgages with a fixed interest rate of which the monthly payments and interest costs remain the same during the term. It also includes variable rate mortgages and variable payments whose monthly installment changes with fluctuations in the central bank’s reference interest rate.

The Bank of Canada newspaper found that floating rate mortgages now make up about a third of all outstanding mortgage debt. In 2019 that is one fifth.

The central bank raises interest rates to curb consumer price growth. It doesn’t specifically target house prices, but Ms. Rogers suggested the bank is quite happy to see those prices fall. Nationally, house prices fell by about 10 percent compared to the peak in February.

“We need lower home prices to restore equilibrium in the Canadian housing market and make home ownership more affordable for more Canadians,” said Ms. Rogers.

So far, however, rising interest rates have actually made homes less affordable, with rate increases more than offsetting falls in house prices. The Royal Bank of Canada’s national aggregate affordability measure hit its worst level on record in September.

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