Higher interest rates are coming for variable- and fixed-rate mortgage borrowers

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The Bank of Canada’s interest rate hike of another quarter of a percentage point will dial up the financial pain felt by borrowers with variable-rate mortgages and some of those with fixed rates.

The central bank’s decision to increase its trend-setting rate to 4.75 per cent will immediately affect a broad swath of Canadians with variable-rate loans, who may see their debt payments reset upward or their mortgage amortizations stretch out.

But the central bank’s move also highlights concerns about stubbornly high inflation amid a surprisingly resilient economy, worries that are affecting financial markets and putting upward pressure on interest rates for new and renewing mortgages as well. That, analysts warn, represents a challenge for new homebuyers and those with upcoming mortgage renewals, two groups who are overwhelmingly choosing fixed rates in the current environment.

Overall, the latest rate increase will likely drive a further uptick in consumer delinquencies and weigh on a recent rebound in home prices, experts say. It could also have ripple effects in the rental market, forcing some landlords to off-load investment properties due to rising mortgage costs.

The first people to feel the sting of another interest rate increase will be Canadians with debts that have variable interest rates and variable payments. Among them are borrowers with adjustable-rate mortgages and those who have lines of credit.

For example, a homeowner with a mortgage of about $664,000 amortized over 25 years, an adjustable rate of 5.55 per cent and a monthly payment of around $4,100 would see their rate climb to 5.8 per cent and their mortgage instalment increase by around $100 a month, according to calculations provided by Ratehub.ca, a financial products comparison site.

While the payment increase itself is contained, it’s the cumulative effect of central bank hikes since March, 2022, that will weigh on many mortgage holders, said James Laird, co-chief executive of Ratehub and president of mortgage lender CanWise. The central bank has raised its benchmark rate by 4.5 percentage points since last March.

Many adjustable-rate mortgage holders likely expected the Bank of Canada’s January rate hike to be the last of its current tightening campaign, and for rates to start declining in late 2023 or early 2024, Mr. Laird said. Now, those homeowners “are going to have to make their household budgets work with the higher payment, which will be coming out at the next mortgage payment.”

Higher mortgage rates will also hurt real estate investors with variable mortgage rates, said Victor Tran, a mortgage and real estate expert at online rates comparison site Ratesdotca. Especially among those who haven’t been able to cover their costs with rental income for months, “we will likely see some forced sales due to pressures from rising housing expenses,” Mr. Tran said via e-mail.

Canadians who have accumulated debt through lines of credit will also see their payments go up. While many borrowers use home equity lines of credit, the rate increases will also affect Canadians who don’t own a home and have been relying on unsecured lines of credit, which aren’t backed by an asset such as real estate.

Payment increases on unsecured lines of credit could help drive up delinquencies for borrowers who don’t have a mortgage, said Rebecca Oakes, vice-president of advanced analytics at Equifax Canada. Those debtors are typically younger, lower income and more financially vulnerable than homeowners, she said.

But Ms. Oakes is also concerned about mortgage holders increasingly missing other debt payments. Signs of financial stress among this group were already on display in the first three months of the year, which revealed a growing number of those borrowers falling behind on some of their nonmortgage debt, according to a recent report by Equifax.

For some Canadians who hold mortgages with variable interest rates and fixed installments, the rate hike will mean hitting the so-called trigger rate – the interest rate level at which the payment amount can no longer make a dent in the mortgage principal and 100 per cent of it goes toward covering the interest.

When that happens, some lenders require that borrowers increase their payment amount, make a lump-sum payment toward the principal or lock into a fixed rate.

But many mortgage holders who’ve hit the trigger rate haven’t been asked to pay more so far, Desjardins economists Royce Mendes and Tiago Figueiredo noted in a recent report. Instead, a number of financial institutions have added any interest amounts not covered by the borrowers’ payments to the principal amount outstanding and extended their amortizations – the time it takes to fully pay off the mortgage.

These borrowers, though, will face payment shock at renewal, when lenders reset amortizations back to the original schedule, experts warn.

Around three-quarters of all mortgages with variable rates have fixed payments, according to research from the Bank of Canada. And among mortgages with variable rates and fixed payments, about three-quarters had already hit their trigger rates before the latest central bank hike, according to Mr. Mendes and Mr. Figueiredo.

Higher payments are also a concern for borrowers with fixed-rate mortgages whose loans are coming up for renewal soon. Interest rates on new fixed-rate mortgages have risen by roughly half a percentage point since the start of May, reflecting worries in the bond market about persistent inflation, Mr. Laird said.

Over the past year, borrowers with fixed‑rate mortgages taken out five years prior have been facing “materially higher payments” at renewal, Mr. Mendes and Figueiredo noted in their report in late May.

Ms. Oakes expects delinquencies among mortgage holders to rise gradually as those renewals saddle homeowners with larger installments.

Canada’s mortgage stress test requires federally regulated lenders to vet borrowers’ finances to ensure they’d be able to keep up with higher interest rates. But mortgage rates have now climbed beyond the stress test rate some homeowners qualified for, Ms. Oakes noted.

Another concern is that some mortgage holders may have accumulated significantly more debt than they had at the time of their stress test, she said.

Some homeowners will be able to handle even sizable payment increases by cutting down spending, Ms. Oakes said. But, she added, “you’ll have some that can’t manage, and you’ll see delinquencies rise.”