Bank of Canada approximates mortgage payments to hike up to 40 per cent
The Bank of Canada estimates that mortgage borrowers will see a spike of 20 to 40 per cent in their monthly payments when they renew their loans over the next few years.
So far, the bulk of borrowers have not felt the sting of higher interest rates because their mortgages have fixed monthly payments. But the bank said that by 2026, nearly all borrowers have to renew their mortgages, resulting in higher payments.
“In light of higher borrowing costs, the Bank of Canada is more concerned than it was last year about the ability of households to service their debt,” the central bank said in its annual Financial System Review. “More households are expected to face financial pressure in coming years as their mortgages are
The bank also flagged financial stability risks related to increased stress in the global banking system, which have come to the fore in recent months with the failure of several U.S. banks and the emergency sale of Credit Suisse. Rising interest rates have revealed cracks throughout the financial system, and the central bank warned that financial institutions whose business models rely on low interest rates could be particularly vulnerable.
The bank said about one-third of Canadian mortgages have already seen an increase in payments compared with February of last year, before the central bank started hiking its benchmark interest rate from 0.25 per cent to 4.5 per cent. The vast majority of mortgage borrowers are up for renewal over the next three years, with most renewing in 2025 and 2026.
Borrowers with variable-rate mortgages have shouldered the largest interest rate increases as their loan is tied to the Bank of Canada’s benchmark interest rate. But given that most variable-rate borrowers have fixed monthly payments, they have not had to pay more every month. Instead, a higher share of their monthly payments has gone toward interest and their amortization periods have lengthened well beyond 30 years.
When these borrowers renew their loans, they will be required to revert back to their original amortization period unless they refinance and take out a new mortgage. If they go back to their original amortization period at renewal, their payments will have to increase by 40 per cent, according to the central bank’s calculations.
For borrowers with fixed-rate mortgages where the interest rate remains steady for the term of the loan, the bank estimates that their monthly payments will increase between 20 per cent and 25 per cent.
Given that the job market has remained robust and unemployment is low, the bank said higher mortgage payments “should be manageable for most households.” However, the bank also said the impact will be more significant for some households.
The bank said some signs of financial stress are starting to appear, in particular among those who bought during pandemic’s real estate frenzy when interest rates were near zero. Households that took out a mortgage between 2020 and 2022 are carrying over about 17 per cent more credit card debt on average than those that took out a mortgage between 2017 and 2018, said the report.
“Households appear to be managing, but pockets of strain are emerging,” said the report.
The higher borrowing costs triggered last year’s drop in home prices. That chipped away at the equity in homeowners properties and pushed some borrowers underwater with their loans – they owe more than the current value of their property.
Alongside risks emanating from Canada’s housing sector, the central bank also flagged vulnerabilities in the global financial system, which could end up reverberating through Canadian banks.
Rising global interest rates have cratered bond prices, leaving large losses on the balance sheets of financial institutions. It has also changed depositor behaviour, with some people pulling their money out of deposit accounts in search of higher interest rates — a move that impacts bank funding costs.
Cracks in the financial system became visible with the failure of Silicon Valley Bank in March, followed by the failure of three other regional U.S. banks and the sale of Swiss lending giant Credit Suisse to rival UBS Group.
“These events have exposed vulnerabilities – notably, business models that rely on an environment of low interest rates and low volatility – and serve as a reminder that risks can emerge and spread quickly,” the bank said.
So far, Canadian banks have been relatively unscathed by the tumult in the U.S. and Europe. But the central bank warned that Canada’s financial institutions “are not immune to international developments.”
Canadian banks rely heavily on wholesale funding – that is, raising money in markets to fund their lending activity. That makes them vulnerable if global credit markets weaken or seize up altogether, as happened at the outset of the COVID-19 pandemic in March 2020 and during the 2008 financial crisis.
Despite the risks, the central bank said the country’s banking system should be able to withstand a significant shock. Central bank staff conducted a “stress test” on Canada’s banking sector in 2022. They concluded that even in the event of a severe and prolonged recession, “the capital position of major Canadian banks would be weakened but would not breach minimum requirements.”
The central bank flagged several other risks, including potential defaults in the commercial real estate sector and among small businesses.
“Market valuations of firms in the office space subsector have decreased. If some of these commercial real estate firms were to default on their loans, lenders could face credit losses,” the bank said.
It also pointed to the risk of cyber attacks and of inaccurately measuring and managing the impact of climate change.
Part of this article was reported by Globe and Mail