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The meteoric rise in the Bank of Canada’s key rate since March 2022, in order to counter inflation, has raised fears of the deployment of active ingredients that could have the effect of a time bomb in the mortgage sector. Are we really on the verge of a financial catastrophe in this sector? Some doubt it.

First, let’s clarify one point. It is not because the Bank of Canada increases its key rate that holders of an adjustable rate mortgage instantly suffer the repercussions. In fact, more than three-quarters of these borrowers benefit from fixed payment repayments. Consequently, many mortgage industry experts are far from being in panic mode. Instead, they accuse the media of crying wolf.

“Each time the rate rises, the media present us with tables illustrating the direct consequences of these increases on the monthly payments of owners who hold a variable rate mortgage,” underlines Denis Boudreau, vice-president of the Specialized Sales Group and specialist mortgage at BMO. However, in several financial institutions — unless otherwise indicated in the contract — owners who hold a variable rate mortgage will continue to pay the same monthly payment throughout the duration of the agreement. “And this, until the next renewal,” he continues.

Therefore, whether they benefit from a fixed or variable rate, holders of a mortgage loan signed for a period of five years at the end of 2021 or at the beginning of 2022 remain very little affected financially by their mortgage payments. “Their budget will not, strictly speaking, suffer the real repercussions of the historic increase in the key rate before fall 2026, or even winter 2027,” specifies the BMO mortgage expert.

Negative monthly payments

However, most holders of an adjustable rate mortgage are currently paying negative monthly payments. Their payments no longer cover the interest on their loan, which means that the principal of the loan increases from month to month rather than decreases. “If these people leave their payments as is until their next renewal, the amortization of their debt risks stagnating. In the worst case, the repayment of this debt risks being extended by several years,” warns Denis Boudreau.

If they have not already done so, he strongly recommends that owners who find themselves in this situation contact an advisor at their financial institution to get the facts on this subject. Most financial institutions, he says, have already been communicating with their customers for several months to explain the situation to them and offer them various options to adjust their payments.

Limit rates under the microscope

Certainly, the Bank of Canada monitors the rate limits for borrowers whose variable rate loans come with fixed payments. This rate, called limit, is the interest rate where the portion of the payment allocated to interest corresponds to the total amount of the payment. At this time last year, more than half of holders of variable rate mortgages with fixed payments had already reached the rate limit.

No bomb, but…

In the eyes of CPA Canada’s chief economist, David-Alexandre Brassard, it would be very surprising if the recent increases by the Bank of Canada, having caused the key rate to jump from 0.25% to 5% in less than 18 months , blow everything up. Figuratively, of course.

First, he says, not everyone has to weather the storm. “You should know that almost half of residential property owners in the country (45%) own their home 100%. They are therefore not affected by increases in mortgage rates,” indicates the professional.

In addition, if we dissect the market of mortgage loan holders in the country, that is to say a little more than one in two owners (55%), less than a third of them have a variable rate mortgage, specifies the economist Brassard. “There are also 20% of fixed rate mortgage borrowers who have had to renew their agreement since the key rate is above 3%. Roughly speaking, one in four homeowners in the country is saddled with a considerably more expensive mortgage.”

Note that a large portion of variable rate borrowers signed a few months before the first increase in the key rate in March 2022. In January 2022, the industry reported that more than 50% of mortgage holders in the country needing to renew or sign a new agreement had just opted for a five-year variable rate contract. Never seen. For comparison, barely 10% of them chose this formula two years ago.

Extension of depreciation

“History shows that the economy has always ended up adjusting,” continues David-Alexandre Brassard. No financial institution wants to see house keys piling up on their desks. Moreover, he presumes that one of the solutions favored by the financial authorities will undoubtedly be to extend the period of amortization of mortgage debts to 35, perhaps even to 40 years.

“However, this is not the most exciting solution,” he warns. If the system moves forward with an extension of the duration of amortizations, there is a risk of causing a financial imbalance within family budgets. “By increasing the duration of debt repayments, we increase the investment of individuals in the real estate portion. Which means less money in their savings and retirement plans,” explains David-Alexandre Brassard.

The Canada Mortgage and Housing Corporation also shares this opinion. The president and CEO of the organization, Romy Bowers, maintains that the extension of amortizations will not improve access to property… and will instead reduce net worth. Remember that under current lending standards in Canada, borrowers must repay their mortgage loan over a maximum period of 25 years when the down payment is less than 20%. If the latter exceeds 20%, the amortization can be spread out over 30 years.

Longer to pay, and then?

Mortgage broker Nancy Canuel, of Multi-Prêts, believes on the contrary that this extension would be a good way to defuse the possible time bomb that many fear. Even if it is a temporary extension. “This solution would allow borrowers to take a breather and review their real estate payment strategy. After all, a key rate of 5% is not that dramatic. This was the reality 20 years ago. It is the rapid increase in less than 18 months and the overbidding of houses during the pandemic which suggest less happy upheavals,” says this professional who has been operating in the market for at least two decades.

Nancy Canuel believes that the real estate market is not in danger. “That doesn’t mean there won’t be collateral damage,” she warns. Financial crises and budgetary tightening, especially those that we don’t see coming, always leave their mark. “The real estate market is not in danger of collapsing, but the situation risks causing situations of over-indebtedness, which will put strong pressure on the finances of many households. This is the kind of bomb we would like to avoid.”

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