Banks are contacting many clients with variable mortgages to inform them that they’re reaching their trigger rate, signalling higher monthly costs for a growing number of homeowners and a longer payback period.
The vast majority of Canadian variable mortgages have fixed payments, meaning that payments stay the same even as interest rates rise moderately. Instead of a payment increase, the portion of your payment that goes toward interest changes, as does your amortization period.
But because interest rates have climbed dramatically this year as central banks battle inflation, variable mortgages are starting to hit what’s known as the trigger rate – the rate at which the monthly payment would not be enough to cover the interest owed. Usually, it means homeowners must increase their mortgage payments, and those increased payments will only be covering interest instead of chipping away at the loan’s principal.
Most people who signed onto variable-rate mortgages more than a couple of years ago wouldn’t have given their trigger rate a second thought, said Ron Butler, a broker with Butler Mortgage Inc. After all, interest rates have been on a generally downward trend for more than a decade.
Mr. Butler and other industry participants said banks have started to issue notices to clients whose variable mortgages are hitting the trigger rate.
TD Bank said it pro-actively monitors customer profiles and has been reaching out to find the appropriate next steps for a borrower when the trigger rate is breached.
“While the portion of customers who will hit the trigger rate will grow as interest rates rise, customers are not required to act when they hit the trigger rate,” said Olympia Baldrich, vice-president of real estate secured lending and TD Bank Group, in a statement.
“There are several options for them … we will work with the customer in that instance to find the solution that is appropriate based on their specific circumstances.”
Ms. Baldrich added that many of the borrowers TD has reached out to have opted to increase their payments.
In a recent report, Dominique Lapointe, global macrostrategist with Manulife Investment Management, said the majority of new mortgages between July, 2021, and June, 2022, were variable-rate mortgages, and those borrowers are at risk of serious sticker shock when they go to renew their variable mortgage.
Mr. Lapointe said most homeowners can survive without too much financial pressure right now, but the real cause for concern is if interest rates remain high for two or more years and homeowners make zero progress on their principal loan amount in that time.
He added that borrowers who currently have a 30-year amortization rate would be at a particular risk for unaffordable payments in this scenario, as their payments would theoretically increase greatly to maintain their repayment schedule when they renew their mortgage.
“This is what worries us the most,” said Mr. Lapointe.
“The systemic risk will really come if the Bank of Canada has to keep rates high for longer than we think.”
The bright side is that the immediate impact on many homeowners’ monthly payments is likely to be modest.
For example, Mr. Butler says a homeowner who signed on to a mortgage in 2021 with a $2000 payment and 25-year amortization would have had $440 going toward a 1.45-per-cent interest rate. That same consumer would have hit their trigger rate by now, and would be paying $2,021, though all of it would go toward interest.
But with another Bank of Canada interest-rate hike expected next week after last month’s overnight rate increase to 3.25 per cent, that payment could increase by hundreds more. Costs would only rise further with any more rate hikes by the Bank of Canada.
“We’ve had some analysts suggest that a 5-per-cent overnight rate isn’t impossible,” said Mr. Butler. “It’s stressful, it’s very stressful.”
Mr. Butler advised people with variable mortgages to ask their lender about all the options they may have in a high-interest landscape, which vary between providers. Some providers allow your mortgage to grow up to 80 per cent of your home’s value, which could be an option for people who can’t afford higher payments.
He added that some consumers saw interest hikes coming and switched to fixed-rate mortgages a year ago, but that ship has long since sailed for people looking to be pro-active, as they’d be locking into some of the highest rates in more than a decade.
It’s a view echoed by Mr. Lapointe, who noted that “rates have arguably more room to decline than increase over the coming years.”
For homeowners feeling stressed about their variable mortgages, Mr. Lapointe said now is the time to consider increasing payments or making lump-sum contributions if possible to chip away at your principal before higher rates kick in.
Nasma Ali, founder of One Group Toronto Real Estate, said clients and people in her community are afraid of what comes next. That fear is compounded by the fact that there isn’t an easy exit from homeownership right now, with weakness in the real estate market. Inflated rental markets in many major cities are also not a financially appealing option right now.
At the moment, Ms. Ali said there isn’t a sense of panic among homeowners – she thinks many people will take the next few months to consider their options as the environment around interest rates plays out. However, with rates expected to rise, she thinks more people could move to sell by next year.
“Next year is going to be an interesting year and it’s not going to look pretty for a lot of people,” said Ms. Ali.