With two-decade highs in mortgage rates and record household debt levels, you’d think more people would be defaulting on their mortgages.
But that’s not the case, according to the Canadian Banker’s Association (CBA). Just 15 out of 10,000 mortgaged households are 90-plus days behind on their payments, near the lowest level in decades, it says.
Four out of 10 mortgagors must borrow to cover daily expenses, up 45 per cent since the survey began in August, 2020.
Seventeen per cent of mortgagors are falling behind on their bills such that they have to use costly online or payday lenders.
And this data is old – from December. Since then, the Bank of Canada has turned the screws on borrowers further, boosting rates twice more, with another hike likely next week.
“The current combined effects of high household indebtedness, the rapid increases in interest rates and the increased cost of living” has created “severe financial stress,” FCAC says.
Yet, mortgage arrears are near record lows.
Something doesn’t add up.
Kicking the can…
Arrears are still low largely because it takes time for defaults to appear after rates surge. Moreover, credit quality at banks has improved since regulators implemented stricter underwriting policies after 2017.
But this is more than that. This is also the government doing its best to keep arrears low.
And this is just the latest government lifeline for borrowers. Ever since the pandemic, when one in six borrowers were granted mortgage deferrals, Ottawa has pressured banks to work with borrowers who can’t pay.
Banks will increasingly have to do things like lower distressed borrowers’ payments with amortization extensions, defer payments and not charge troubled borrowers higher rates at renewal. Banks are even being told to waive mortgage prepayment penalties in forced-sale situations.
Other things being equal, government intervention will keep arrears artificially low for longer, people will have more flexibility around making their contractually required payments. “The customer is only put in the arrears statistics if they do not pay after the bank’s relief measures are over,” the CBA said in an e-mail today.
A heaping helping of side effects
Shielding borrowers could also keep home prices less affordable for longer – given fewer distressed sales. (Sorry first-time buyers. You lose again.)
It could also keep the housing market stronger, which in turn supports housing inflation instead of deflation, which keeps interest rates higher for longer. That keeps more money in people’s pockets, at least temporarily. It also keeps more credit flowing, since default risk is pushed into the future.
Ultimately, it makes it harder for the Bank of Canada to fight inflation, which in turn keeps borrowing costs higher for longer. If you asked the Bank of Canada, they’d probably say rate hike cycles are supposed to be tough on borrowers. That’s the whole point.
The Finance Minister told reporters Wednesday that the FCAC’s guidelines are “intended to protect Canadians by ensuring their financial institutions treat them fairly and provide them with the tailored mortgage relief they need.”
That benefits borrowers in hardship, but for every action, there’s an equal and opposite reaction. Banks’ reaction will be at least twofold:
For one, the FCAC warned it would monitor banks’ compliance with these measures. One should expect banks to pass through any compliance costs to consumers – all consumers – by way of higher overall interest rates on mortgages and higher fees.
For another thing, some banks will incrementally tighten underwriting standards to minimize their chances of providing mandatory “mortgage relief.”
Odds are, any underwriting changes would be only incremental. Yet, for a small share of borrowers at the margin – those who get declined for a mortgage – many would be relegated to higher-cost non-federally-regulated lenders. Ironically, they’d have an even greater need for mortgage relief at those non-bank lenders and have less chance of getting it, because FCAC guidelines wouldn’t apply to those lenders.
Arrears will climb; just give it time
It’s hard to pay a mortgage when you’re living paycheque to paycheque and you lose your job.
With more than 4.5 percentage points of rate hikes, it’s a matter of time before unemployment starts climbing. When it does, arrears will follow because there’s only so much rope a bank will give you. But it will take longer than it did in the past, given all the “support” mortgage borrowers now enjoy.
And heck, who knows what policy makers will think up next as they try to remove risk from the housing market and shield our financial system from normal cyclical risks. Maybe they’ll adopt British-style relief measures prohibiting banks from repossessing your home within 12 months of your first missed payment.
Whatever they do, it won’t be a free lunch for consumers – particularly those who pay their mortgages on time.
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