Welcome to Mortgage Rundown, a quick take on Canada’s home financing landscape from mortgage strategist Robert McLister.
Next Wednesday will likely bring about the biggest test for floating-rate borrowers in years.
On March 2, the Bank of Canada is expected to lift its key lending rate to restrain the most serious inflation threat Canada has seen in decades.
The market expects next week’s hike to be the first of roughly two-plus percentage points of rate increases through 2023.
That’s enough to give variable mortgagors the jitters. And no less than 54 per cent of borrowers have been choosing record-low variable rates, according to the latest monthly data from Statistics Canada.
Variables have historically cost less than fixed mortgages over most five-year spans. But floating-rate borrowers weren’t so lucky in the previous rate-hike cycle. Had you got the best available variable rate five years ago – just before the Bank of Canada started hiking rates, you would’ve easily paid more interest than had you chosen the lowest fixed rate at the time – assuming you didn’t break the mortgage early and pay a penalty.
The same could be true this time around if market rate expectations pan out. In fact, if Canada sees 200 basis points of rate tightening – as the bond market is pricing in – the Bank of Canada would have to start reversing those hikes within three-and-a-half years for new variable borrowers to pay less than those in a five-year fixed rate. (There are 100 basis points in a percentage point.)
Can home owners afford 200 bps of rate hikes?
Average mortgage amounts have never been larger. So it’s natural to wonder whether those without fixed rates can handle a two-point rate increase.
The answer is generally yes. Most mortgagors have ample home equity or financial resources to fall back on and the overwhelming majority are stress tested – that is, they must prove they can afford at least a 200-bps rate increase.
But not everyone is so comfortable. More than one in five are highly leveraged, according to Bank of Canada data. And while the government’s stress test makes you prove you can afford your mortgage payment, property taxes, heat, condo fees and major credit payments, here’s what it doesn’t factor in: groceries, child care, commuting/gasoline, utilities, home maintenance/repairs, internet, cellphones, TV (streaming/cable), vacations, dining/entertainment, education, home, car and life insurance, and so on.
In other words, the mortgage stress test doesn’t assess your “real-life” budget.
Prior to these 31-year highs in inflation, most Canadians were already living beyond their means – more than half being just $200 away from not covering their monthly expenses.
A 150-plus-bps rate increase wouldn’t help. It would boost payments by more than $400 a month for someone mortgaging the average Canadian home with 20 per cent down and a 25-year amortization.
That would challenge up to 61 per cent of those renewing their mortgage in the next year. That’s how many worry they’ll be in “financial trouble,” according to a recent MNP poll, if interest rates “go up much more.”
Fortunately, most floating-rate borrowers have fixed payments. They won’t experience any payment shock until they renew or refinance.
It’s the minority in adjustable-rate mortgages that’ll feel the brunt much quicker. Their payments will rise in lockstep with prime rate.
The good news is, none of this implies mass mortgage defaults. That is, as long as economists are right and home values don’t crash.
Instead, the (temporary?) end of record-low mortgage rates likely means a less disastrous outcome: a healthy eventual reversal of home prices, noticeably less consumer spending in two to three years, and a moderate uptick in missed mortgage payments.
Mortgage rates in a holding pattern
In the lull before next week’s big Bank of Canada meeting, mortgage rates are little changed.
Short term, there’s a chance that if things got bad enough in Ukraine, investors would flood into safe government bonds. That could push down bond yields and potentially ease five-year fixed rates somewhat. But with the consumer price index disturbingly high and rate hikes on deck, the medium-term trend in fixed rates remains up.
Rates in the accompanying table are as of Wednesday from providers that advertise rates online and lend in at least nine provinces. Insured rates apply to those buying with less than a 20 per cent down payment, or those switching a pre-existing insured mortgage to a new lender. Uninsured rates apply to refinances and purchases over $1-million and may include applicable lender rate premiums. For providers whose rates vary by province, their highest rate is shown.
Robert McLister is an interest rate analyst, mortgage strategist and columnist. You can follow him on Twitter at @RobMcLister.