Advisers, brokers urge clients to plan for mortgage renewal payment shock

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With hopes of a rapid return to low interest rates now fading, it’s time for Canada’s mortgage borrowers to start planning ahead for big payment increases at renewal, experts say.

After pausing interest-rate increases from February to May, the Bank of Canada is back on a hiking spree. Some analysts now say another quarter-point hike is possible in September, after the central bank raised its trendsetting rate to 5 per cent from 4.5 per cent with two increases in June and July.

And in its latest interest-rate decision, the Bank of Canada said it doesn’t expect inflation to return to its 2-per-cent target until the middle of 2025. The statement raises the odds that interest rates will remain elevated for the next several years, economists say.

So, mortgage brokers and financial planners are urging clients to explore their options and, in some cases, take steps now to reduce payment shock at renewal – even if borrowers still have several years until the end of their mortgage term.

To grasp the size of the potential financial hit, it helps to run some numbers. As an example, consider the case of a hypothetical borrower who bought their first house in mid-2021 at what was then the national average home price of $679,000.

Let’s assume they purchased the property with a 15-per-cent down payment, a mortgage that renews in five years and 25-year amortization period to pay off the loan in full. For this borrower, payment shock at renewal is a risk in two main scenarios: if they chose a fixed rate or they chose a variable-rate mortgage (VRM) with a fixed monthly or other regular payment.

A third option is an adjustable-rate mortgage, for which the interest rate and the payment both usually move up or down following changes in the Bank of Canada’s key rate. But these borrowers have already seen their payments soar, as the central bank raised its rate from 0.25 per cent at the start of March, 2022, to 5 per cent in July.

Among homeowners with fixed payments, those who bought early in the pandemic and will renew a five-year mortgage in 2025 and 2026 may be in for some of the steepest increases, according to an analysis by Desjardins economists Royce Mendes and Tiago Figueiredo.

In our scenario, let’s assume the hypothetical homebuyer got a five-year fixed rate of 2.04 per cent in June, 2021, a competitive nationally-available rate at the time, according to financial products comparisons site Ratehub.ca. Their current monthly payment would be $2,524.

What might be their new mortgage instalment at renewal in June, 2026?

The answer requires some guesswork around future interest rates. Let’s assume the new rate will be 4.8 per cent, the rate Bank of Canada staff used in a recent simulation of the impact of higher interest rates on mortgage payments. The new payment would be $3,215, an increase of nearly $700 a month.

Plotting scenarios for a VRM is trickier, as it requires assumptions about both future mortgage rates and the borrower’s future mortgage balance at renewal. With these mortgages, rising rates mean more of the fixed payment goes toward interest and less toward paying down the principal.

With the recent spate of rate increases, more than three-quarters of such borrowers have found that their payment isn’t even enough to cover the full amount of the interest due. When that happens, the mortgage balance increases instead of shrinking, as lenders add the unpaid portion of the interest to the principal balance. While some borrowers facing this scenario have taken steps to increase their instalments or reduce their balance with lump-sum payments, others have not.

To keep things simple, let’s assume the homeowner in our scenario would face a payment at renewal in mid-2026 that is 44 per cent higher than their current payment. That’s approximately the size of the average payment increase that the Bank of Canada’s simulation finds homeowners renewing a VRM in 2026 would need to shoulder to stay on track with their original amortization schedule. (The simulation is based on some VRM holders facing higher payments before renewal and others seeing the increases at renewal. Also, the analysis precedes the last two central bank rate increases this June and July.)

Based on a 1.3-per-cent mortgage rate in June, 2021, a VRM holder in our scenario would have a monthly payment of $2,317, according to Ratehub. A 44-per-cent increase would mean a payment of $3,336, or $1,019 more.

With a fixed-rate mortgage or a VRM, the payment increases for our fictional homeowner are large enough to warrant significant budget adjustments on a middle-class household income. That’s why some mortgage brokers and financial advisers are urging some clients to start preparing for the potential financial blow well in advance.

At mortgage lender CanWise, president James Laird said an unusually large number of borrowers are wondering about possible renewal scenarios even if they still have years left on their mortgage terms.

Not all mortgage holders stand to see their payments jump at renewal, said Mr. Laird, who is also co-chief executive of Ratehub. The concern is mostly about recent first-time homebuyers who haven’t made much of a dent in the principal balances, and those who secured very low rates in early stages of the pandemic.

For borrowers facing potentially large increases, Mr. Laird’s advice is to plan for the worst-case scenario. “Be conservative with your assumptions so that the numbers are better than your assumptions,” he said, meaning chances will be high that reality will work out better than what you prepared for.

To set assumptions, borrowers should talk to their mortgage broker or lender, who can help them explore various rate scenarios at renewal and, in the case of VRMs, estimate how much the outstanding balance might be in different circumstances, said David Larock, a mortgage agent with TMG The Mortgage Group.

At Spring Plans, financial planner Julia Chung said she’s bringing up the issue of upcoming renewals herself if clients who have a mortgage don’t ask about it.

Once clients gather the necessary information from their lender or mortgage broker, Ms. Chung creates net worth and cash-flow projections. Those scenarios might indicate that changes to spending or saving might become necessary, she said.

“Are we going to have to skip a holiday? Delay retirement?” Ms. Chung said via e-mail, adding that other variables such as investment return rates and income tax considerations would also be factors. Seeing the scenarios helps clients re-evaluate their priorities and make good decisions, she said.

Some borrowers will also have the option to lengthen their amortization to minimize payment increases, said Mr. Larock, the mortgage broker. With federally regulated lenders, such changes typically require them to pass a new mortgage stress test, a process that vets their finances at an interest that is higher than the one their lender is offering.

But Mr. Larock said in the current environment, he’s seen lenders allow borrowers to stretch their amortizations without having to requalify, adding that federal regulators are giving mortgage providers unusual flexibility to help struggling homeowners.

However, borrowers with VRMs who have already fallen considerably behind their original timetable for paying off their principal are already enjoying the benefits of extended amortizations, he said. Those homeowners will likely face payment increases because of higher interest rates and the fact that lenders typically reset amortizations in line with the original repayment schedule at renewal.

For VRM holders whose amortizations have temporarily stretched beyond 30 years, the best course of action is to calculate how much their payment would be if the size of their instalments had adjusted along with higher interest rate, and “try to pay as close to that payment as you can,” he said. “Even if you can’t get all the way there, paying some principal is better than paying no principal.”