Interest-rate cuts won’t bring relief to many with variable-rate mortgages

Open this photo in gallery:

Canadians with variable-rate mortgages who had to boost their payments because of rising interest rates may not see those payments decrease if their borrowing costs start to decline.

In Canada, about three-quarters of mortgages with variable rates, which are tied to the Bank of Canada’s benchmark rate, have fixed payments. But unusually steep central bank rate hikes over the past 13 months have forced some of those borrowers to increase their payments to ensure they would continue to cover at least the interest on their loans.

Now variable-rate mortgage borrowers are eyeing some relief toward the end of the year, when financial markets expect the Bank of Canada will begin to cut interest rates. However, some lenders, including Royal Bank of Canada RY-T, won’t lower mortgage payments for homeowners who had to bump up their normally fixed installments.

“When the Bank of Canada rate decreases, payments will remain the same. Part of the payment will now be applied to the principal instead of only covering the interest,” Arjun Lombardi-Singh, spokesperson for RBC, told The Globe and Mail in an e-mail.

Many people with variable-rate mortgages were taken off-guard when the Bank of Canada embarked on one of the fastest rate-hiking cycles in history. Some with adjustable payments saw their mortgage installments rise sharply. Those with fixed payments saw more and more of their payments applied to the interest rather than the principal balance. This lengthens the mortgage amortization, or the time it takes to pay off the loan in full.

Many of these mortgages hit the so-called trigger rate – the point at which none or very little of the payment goes toward reducing the principal. To ensure that borrowers would continue to pay off some of the mortgage balance – or at least continue to cover the interest due in full – some lenders required borrowers to take action, including by increasing their payments. Other financial institutions suggested that their clients do so, without requiring it.

Meridian Credit Union Ltd. said bumping up payments is one option for borrowers whose regular installments are no longer enough to cover the interest owed. Other options include making lump-sum payments, refinancing, or restructuring their current mortgage.

Asked about whether those larger payments would shrink – possibly back to their original size – if interest rates begin to decline, Allison VanRooijen, vice-president of consumer credit at Meridian, said by e-mail that “traditionally, payments would remain fixed.”

Ms. VanRooijen also noted that “this is a unique time for borrowers given how quickly interest rates have gone up.” However, she did not say whether Meridian would allow payments to decrease for mortgage holders who’ve had to increase their payments because of such extraordinary circumstances if their interest costs decline before the end of their loan term.

About 80 per cent of Canadians who took out variable-rate mortgages with fixed payments during the pandemic housing boom in 2021 hit the so-called trigger rate, according to National Bank Financial. Overall, between 60 per cent and 80 per cent of these types of mortgages have hit the trigger rate irrespective of what year their terms began.

When interest rates fall, variable-rate borrowers with fixed payments will see more of their money going toward the principal, which reduces their amortization. That’s a silver lining for those who had to beef up their usually fixed payments and aren’t allowed to reduce them, said Frances Hinojosa, a Toronto-based mortgage broker and co-founder of Tribe Financial Group.

Higher payments now may spare variable-rate mortgage borrowers from financial shock after the end of their current mortgage term, when lenders readjust mortgage installments to bring them back in line with the loan’s original amortization, Ms. Hinojosa said.

Those with variable rates who’ve seen their repayment period stretch out as rates rose could face higher payments at renewal, unless they’re able to refinance their mortgage and re-extend their amortization, said David Larock, a Toronto-based mortgage agent with TMG The Mortgage Group.

That’s a potential concern for variable-rate borrowers who did not have to increase their payments, including some who were allowed to stick to their original mortgage installments even after hitting their trigger rate.

Canadian Imperial Bank of Commerce, for instance, did not mandate that borrowers increase payments upon hitting the trigger rate.

Instead, up to a certain threshold, any unpaid portion of the interest is deferred and added to the mortgage principal so that the borrower’s loan balance grows, or negatively amortizes. That threshold was set at 105 per cent of the size of the initial mortgage loan, or its size at its most recent renewal. So far, none of the bank’s clients have seen their loans climb to that threshold, according to CIBC officials. On renewal, these clients will need to go back to their original amortization schedule.

TD also allows negative amortizations up to specific thresholds. Borrowers who had hit the trigger rate should have received a notice from the bank that offered various options, including increasing payments, making a lump-sum payment, conversion to a fixed term, or a refinancing, said TD spokeswoman Ashleigh Murphy. Variable-rate mortgage clients with fixed payments won’t see their payments decline if rates decrease, but more of their payments go toward paying down the principal, she said.

BMO also allows for negative amortizations and the impact on borrowers from a decline in interest rates would also be similar. RBC, however, does not allow negative amortizations.

National Bank does not offer variable mortgages with fixed payments, meaning that payments always rise and fall in tandem with lending rates. Similarly, Bank of Nova Scotia’s main variable-rate mortgage product has adjustable payments.

Robert McLister, mortgage strategist and editor of MortgageLogic.news, notes that those who are struggling with making payments can always work with their lender to lighten the debt burden, often with no onerous fees or adverse impact to their credit score.

“The feds are trying to codify this with guidelines, but most banks already offer such flexibility. And you typically don’t even need to prove the payments aren’t manageable,” he said. “So I wouldn’t get too miffed about these one-way payment adjustments. Most banks will provide relief if a borrower needs it.