Fixed or variable, most mortgage owners are, or will be, facing higher costs, leading to a growing focus on budgeting.Alexander Raths/Getty Images/iStockphoto
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Higher interest rates aim to tame inflation, but they also lash many Canadians’ finances with significantly higher payments on mortgages. That’s leading to tough conversations for financial advisors meeting with cash-strapped clients whose mortgage payments have jumped much higher than anticipated.
“For the people with variable rates, they’re especially struggling,” says Sajjad Hussain, portfolio manager and senior wealth advisor with Allen Private Wealth Group at iA Private Wealth Inc. in Toronto. “Their mortgage costs have ballooned dramatically.”
Many clients entered into variable-rate mortgages near all-time lows in 2021 and early 2022 before the Bank of Canada (BoC) began hiking interest rates rapidly in March – now up 475 basis points – with possibly more to go.
In some cases, higher debts have a domino effect, affecting clients’ ability to save for retirement or even hold onto their homes, Mr. Hussain says.
It’s not just variable mortgages. It’s individuals with home equity lines of credits (HELOCs), who easily made interest-only payments when rates were at historical lows, but are now feeling the squeeze, he adds.
Clients with fixed-rate mortgages could also soon face much higher rates, says Jeffrey Ryall, investment counsellor and certified financial planner (CFP) at Cardinal Capital Management Inc. in Winnipeg.
“The Bank of Canada has stated most fixed-rate mortgages will be renewed by 2026,” he says. “While people still have options, there’s an element of behavioural finance in which attitudes are risk-seeking to get the lowest rate.”
Speculating with mortgages
This attitude was instilled by more than a decade of low interest rates, especially amid the pandemic, when offered variable-rate mortgage fell below 1 per cent and even fixed-rate mortgages were below 1.5 per cent. The result was a lot of risk-on behaviour.
“When interest rates were lower, for example, we were doing a ton of stuff for financial advisors’ clients [like] equity takeouts and then investing in the market because money was so cheap and it was pretty easy to get a good return,” says Matt Leggett, mortgage broker and senior vice president, mortgages at Ratehub.ca in Calgary.
Just taking on a variable-rate mortgage involved speculation, Mr. Hussain argues.
“A lot of people speculated with a variable mortgage three years ago even when fixed rates were very low,” he says. “But speculation only works two ways – it’s really bad or really good.”
The outcome turned out to be “really bad” for many, he adds.
Mr. Hussain says several first-time buyers in high-priced markets such as Toronto and Vancouver, able to get larger variable mortgages amid ultra-low interest rates, are now “in tough spots.”
His advice to clients has consistently been to take a fixed-rate mortgage to provide predictability. Not everyone followed that advice.
Fixed-rate mortgages remain the most popular mortgage, but a BoC report noted variable-rate mortgages grew more common during the pandemic, rising to a third of all mortgages by 2022 from about 20 per cent in 2019.
Budgeting, cutting costs and increasing amortization
Fixed or variable, most mortgage owners are or will be facing higher costs, leading to a growing focus on budgeting.
“Usually, we would do budgeting for clients approaching retirement,” Mr. Hussain says. “We’d call that ‘the future income plan,’ but now, we have something called ‘the current income plan,’” to help clients deal with higher interest rates.
Mr. Ryall adds predictability is paramount today, suggesting a “blend-and-extend strategy could potentially stop the bleeding.” This strategy involves borrowers contacting their lender to get a new five-year, fixed mortgage, potentially with a lower rate than their variable. Individuals with fixed-rate mortgages with low rates that are up for renewal soon could also do the same, locking in at a higher rate.
Although they may be locking in at a higher rate than they currently have, these individuals can secure a new fixed rate they know they can afford, which may also be less than the interest rates on mortgages available two or three years from now if they let their current term run its course.
Those with variable-rate mortgages, who previously qualified under the Office of the Superintendent of Financial Institutions (OSFI) stress test at 5.25 per cent, believing rates would not rise any higher, are already receiving calls from lenders to lock in, says Jackie Porter, CFP with Carte Wealth Management Inc. in Mississauga.
“That’s happening to many newer homeowners,” she says. In turn, she reviews their expenses, particularly those that are discretionary, to cut costs to see if they can keep paying their current rate.
Some may not, so another option could be renewing early to stretch amortization back to 25 or 30 years.
“It’s not optimal, but it’s about today and making sure they don’t default on payments,” Mr. Hussain says.
Others with variable-rate mortgage in which payments don’t increase but amortization does, may already be facing trigger points with lenders because their payments no longer cover paying down the principal, Ms. Porter says.
“So, now we’re having conversations with them to figure out what to do,” she says.
Getting a handle on all debt
Meanwhile, there are other clients who are not as affected by higher mortgage rates, but HELOC debt has become problematic. That includes older clients who helped adult children with down payments on homes.
“We try to reorganize their portfolio to get that HELOC close to zero,” Mr. Hussain says.
That could involve taking capital from tax-free savings or non-registered accounts to pay down the debt. In other cases, restructuring is required.
“A lot of people up for renewal are finding they can’t even qualify anymore because of their total debt load,” Mr. Leggett says.
“So, instead of a straight renewal, they’re refinancing their mortgage to pay off higher-interest debt, which creeps their amortization back up.”
The new normal
Previously, clients had several choices when renewing, but many today have one affordable option – the five-year fixed offering the lowest rate, he says.
Others have smaller mortgages or greater ability to absorb higher costs, and they’re choosing shorter terms at higher rates, hoping interest rates will fall in a year or two, Mr. Leggett adds.
“Some even consider variables,” anticipating interest rates will go down soon, he says.
Regardless of clients’ views, advisors should emphasize that the low interest rate environment of the past decade was probably an outlier, Mr. Ryall says.
“People should get comfortable with another new normal, and that it’s likely interest rates will be in the high 3 to 4 per cent range for a long time.”
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