The Bank of Canada said that by 2026, nearly all borrowers have to renew their mortgages, resulting in higher payments.Sean Kilpatrick/The Canadian Press
The Bank of Canada estimates that mortgage borrowers who renew their loans over the next few years will see a spike of 20 per cent to 40 per cent in their monthly payments.
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 renewed.”
The central bank also highlighted risks related to stress in the global banking system, which has come to the fore in recent months with the failure of several U.S. banks and the emergency sale of Credit Suisse. The rapid rise in interest rates has exposed cracks throughout the financial system, and the central bank warned that financial institutions whose business models rely on low interest rates are 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 majority of mortgage borrowers are up for renewal over the next three years, with most renewing in 2025 and 2026.
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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 that has pushed out their amortization periods well beyond 30 years.
When these borrowers renew their loans, they will be required to revert to their original amortization schedule unless they refinance and take out a new mortgage. If they keep 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 for which 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.
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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.
Carolyn Rogers, the bank’s senior deputy governor, dismissed the idea of permanently extending the maximum amortization for new mortgages. But she said lengthening amortizations for existing borrowers can help provide relief to those struggling with higher mortgage payments.
“Amortizations are a buffer that households can use if they find their payments go up and squeeze their budgets more than they can deal with,” she said at a news conference, adding that extending the loan period was a “good sort of release valve to help deal with temporary increase in payments.”
The bank said some signs of financial stress are starting to appear, in particular among homeowners who bought during the COVID-19 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, the report said.
“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. This proved fatal for Silicon Valley Bank, which collapsed in March after news of losses in its bond portfolio sparked a run on the bank. Since then, three other regional banks in the United States have failed, and Swiss lending giant Credit Suisse CS-N was forced into a shotgun wedding with rival UBS Group.
Rising interest rates have also increased bank funding costs and produced volatility in unexpected corners of the market.
Most notably, a sudden move in bond prices last fall caught British pension funds off guard, forcing them to liquidate bond holdings to meet margin calls. This nearly crashed the gilt (government bond) market, and forced the Bank of England to intervene to prevent a fire sale.
“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 of Canada said.
Canadian banks have been largely 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 seize up, as happened at the outset of the pandemic in March, 2020, and during the 2008 financial crisis.
They’re also exposed to structural changes in the financial system that may increase volatility. The combination of digital banking and social media appears to have increased the speed of bank runs, as evidenced by the rapid collapse of Silicon Valley Bank. And the growth of the asset management industry over the past decade could make it harder for banks to provide liquidity to bond markets in the event of a sudden dash for cash.
“If global financial stress were to re-emerge and prove more persistent, Canada could see more significant spillover effects – especially if stresses triggered a severe global recession and interacted with existing vulnerabilities,” Bank of Canada Governor Tiff Macklem said in the news conference.
The central bank said the country’s banking system should be able to withstand a significant shock. Bank of Canada 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. It also pointed to the risk of cyberattacks and of inaccurately measuring and managing the impact of climate change.