Topping today’s fiction bestseller list is a story of how rising interest rates are no big deal for homeowners.
The plot goes like this: As much as rates rise from current levels, they’ll still be close to what many people paid if they bought homes or renewed mortgages before the pandemic. In any case, these homeowners have passed a stress test that probes their ability to afford higher interest rates than at the time of purchase. There’s no suspense if rates rise because lenders have already ensured they have enough income. Otherwise, they didn’t get a mortgage.
Unfortunately, there are some holes in this plot. The real story is that we could be headed into the most challenging time to have a mortgage since the interest rate surge of the 1980s.
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In a report to be issued Thursday, CIBC Economics offers some context on rate hikes. Variable-rate mortgage payments don’t generally change as rates rise – instead, the amount of payments directed toward principal as opposed to interest falls. With fixed rate mortgages, only about 20 per cent renew in any one year. Over all, about $350-billion in mortgages will be affected by changing rates in 2022.
The report says people who renew mortgages between 2022 through 2024 have a kind of “immunity” that comes from the fact that the mortgage rates they got a few years ago are above current levels. The increase in rates to come may leave those renewing with mortgages that are only a little more expensive than they now pay.
“But without a booster (lower rates in 2025/2026), that immunity will fade for borrowers that entered into mortgages during the pandemic,” CIBC deputy chief economist Benjamin Tal writes. “And given that in the past two years mortgage originations rose by more than 60 per cent relative to their pre-crisis level, that might be a significant shock.”
Homeowners today actually face three waves of adversity, rates being just one of them.
The first wave is the change in spending patterns caused by the gradual return to normal lives and normal spending as we work through the pandemic. People who bought homes in the past 18 months will have to relearn how to factor vacations, entertainment and socializing into their household budgets.
The second wave is rising inflation, which demands more money from you to maintain the status quo. More money to eat the same old food, and drive your SUV the same old distance.
Rising rates, the third wave, are partly a consequence of the inflationary second wave. Rates were always expected to go up as the pandemic eased and the economy firmed. Think of someone with a healing fractured leg no longer needing the support of crutches.
Inflation’s persistence has dialled up the drama associated with rate increases. The phrase “earlier, faster and higher” is being used to describe what some economists see coming for rates in the next 18 to 24 months.
The CIBC report suggests some households will be affected more than others by mortgage rate increases. But even a small increase in costs will be felt. People who buy a home are typically on a financial journey that involves ever-increasing amounts of spending. They have kids, buy vehicles, undertake renovations and develop more sophisticated tastes in even everyday expenses.
On top of this natural rise in spending come the three waves of adversity for homeowners in the pandemic – new spending opportunities in an opening economy, inflation and rising rates. Many households will have to sacrifice, compromise and defer in order to get by, which isn’t unprecedented. Ask boomers about the 1980s and they’ll tell you about just hanging on as they renewed mortgages at rates that peaked at just over 20 per cent.
Surviving rate hikes in the pandemic era will be especially hard for families that own homes and are struggling because of jobs or income lost in economic lockdowns. You get a sense of this precariousness in a recent survey of food bank operators that found the number of visits to their facilities has increased by more than 20 per cent in the past two years.
For a long time, home ownership in Canada has been a non-stop positive feedback loop of low borrowing costs, rising equity and approval from friends, family and society at large. Now, the plot thickens.
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Rob Carrick