Long-time financial advisor Keith Brown heard from a young father who’d seen the payments on his $3.2-million mortgage soar in the last few months. He purchased the expensive house a couple of years ago and took out a $2.2-million mortgage at a low variable rate, with a $1-million down payment. Because his current payments are now at more than $14,000 a month – an extra $57,000 a year – he had come to Mr. Brown for advice.
Mr. Brown, who’s been in the business for 40 years, usually works with high-income families on tax and estate planning. The man was not a client, but he was struck by his predicament.
“You are going from 1.7 per cent or 2 per cent to 6.5 per cent in a period of months,” he says. “People can sustain that for awhile, but eventually they run out of their cash or have to go into savings like RRSPs to pay their bills.
“We are in this market where people have been buying property and they’re over their heads because it’s so expensive. It’s not that unusual to see people paying over 50 per cent of their income on housing – and that’s too high.”
Mr. Brown foresees some crisis situations for a particular group of people if the rate doesn’t come down in the next year. Borrowers have seen Bank of Canada increase its lending rate eight times between March, 2022 and January, 2023, up from a low of 0.25 per cent to 4.5 per cent.
And homeowners who over-leveraged won’t be the only ones affected. Renters will be displaced when those homeowners are forced to sell, or are motivated to find new tenants who’ll pay a higher rent. Some are selling because they believe the market will cool off further in the next couple of years, which will also displace tenants.
“When a property gets sold there’s a much higher risk of people getting evicted in the aftermath, because the [new owner] will move in or do renovations,” says David Wachsmuth, associate professor of urban planning at McGill University in Montreal. Prof. Wachsmuth studies housing markets in Canada and internationally, with a focus on the impact of short-term rental.
“Levels of household debt are very high here, driven overwhelmingly by housing,” he says. “So it’s quite a combination: high debt levels and variable rate mortgages that create a lot of additional vulnerability. You can’t blame people. You see these numbers, and if you wait another year to buy a home, that home is now worth 25 per cent more than last year. So you are incentivized to take on the maximum possible debt.”
Mortgage Professionals Canada released a report last week that showed 20 per cent of 2,029 Canadians surveyed would struggle to make mortgage payments if they increased by just 10 per cent or less. And 37 per cent would struggle if those payments went up by 20 per cent. First-time buyers face the greatest struggle, with more than 14 per cent of them already having difficulty making payments.
Variable rates became more popular during the pandemic because they didn’t have the penalties of a fixed term, says Erica Ma, area vice-president for The Mortgage Group and a director on the board of Mortgage Professionals Canada.
But within a few short months, the interest rate climbed so drastically that nobody could have seen it coming, says Ms. Ma.
“I’ve been in the industry for 15 years and I haven’t seen this rapid change when it comes to the rate,” she says. “Definitely clients are concerned and worried and maybe if they’re a bit over leveraged, feeling the pinch more.
“I think as mortgage brokers being in this industry we haven’t seen as much of a rate hike, so it was a surprise to all of us,” says Ms. Ma, adding that prepandemic, the fixed rate average was 3 per cent. During the pandemic, it averaged around 2 per cent.
“We didn’t think it would come up this high, so definitely it caught a lot of brokers and clients off guard.”
As online mortgage broker Ratehub, co-chief executive officer James Laird said “this is the biggest rate increase we’ve seen in three decades. In most people’s mortgage lifetime, no one has seen this before.”
About 32 per cent of mortgage holders will be renewing their mortgages within the next two years, and at higher rates, according to the MPC report.
And although variable rates grew in popularity, the majority of mortgages were at a fixed rate, and 25 per cent at a variable rate in the second half of 2022.
The knock-on effect of interest rate shock remains to be seen in the coming months.
“If this persists at high rates, you will see people having to renew their houses and put more money down so they can qualify again,” Mr. Brown says.
“That young fellow with the mortgage payment problem had to go into his long term savings like RRSPs so he didn’t go bankrupt.”
He advises that people use the stress test as their payment guide so they pay down their mortgage faster and stay prepared for a higher-rate scenario. The Office of the Superintendent of Financial Institutions set the minimum qualifying rate at the lender rate plus 2 per cent. That means, for example, if the buyer finds a rate of 4.44 per cent, their stress test rate is 6.44 per cent.
Ratehub created a scenario specific to Greater Vancouver to demonstrate how the increase may have played out in the last year for a hypothetical Vancouver homebuyer. In January, 2022, the average home price in Greater Vancouver was $1,190,000. The best five year variable rate at the time was 1.4 per cent. After a down payment of 20 per cent, a mortgage amount of $952,000 amortized over 25 years would require payments of $3,761 a month. By March 8, 2023, the variable rate was at 5.65 per cent and the monthly payments grew to $5,894.
“That means that by March, 2023, the total impact year-to-date for the homeowner is $2,133 more per month, or $25,596 per year on their mortgage payments,” said a Ratehub spokesperson.
That’s a 57-per-cent increase in payment amount.
“The subset of consumers who would be feeling this the most would be, through no fault of their own, those who ended up with terrible timing,” says Mr. Laird, who is also co-founder of Ratehub. “That would mean in a city like Vancouver, buying a new home close to the peak some time around 12 months ago.
“And then if you chose a variable rate with a variable payment, then that would be the group that is experiencing the fastest and sharpest rate hike and also payment hike.”
Overall, that’s a small percentage of buyers, he adds. And people who bought high and were able to make large monthly payments should be able to cover the higher rate because of the stress test. Mr. Laird believes if rates level off, home values could go up toward the last half of the year. In the meantime, homeowners will need to cut back on costs. There’s no easy way around a higher interest rate, says Mr. Laird.
“If we are thinking about this from a society wide perspective, there are a ton of homes that have no mortgage, and there are also a ton that are at 30-per-cent loan to value. So it’s a small subset that would be feeling the pressure. The worst niche that I have seen is if you bought a preconstruction home this time last year, and you locked in at the elevated price and that home is now worth less but you still have to close on it. And rates have gone up. That is the worst combination of things.
“But again it’s a small percentage of the overall real estate market.”
The ones most likely to feel the pressure of homeowner pain are the tenants who rent investment condos and live in laneway homes and basement suites. Insolvency trustee Linda Paul, based in the Fraser Valley, says her low-income clients, mostly younger people, are looking at evictions. In the next year, she says homeowners will likely be making tough decisions.
“I’m seeing individuals who are getting eviction notices. And I don’t want to suggest this is a widespread phenomenon, but I’ve been doing this for over 20 years and I don’t remember seeing people getting evicted before, where they can’t pay their rent and there’s a legal process to remove them.
“And in B.C., you see more and more basement suites, so the mortgage is going up and the homeowner is paying more and they are passing on that cost to the renter,” Ms. Paul says.
Prof. Wachsmuth agrees that life will get harder for the renters who are expected to cover investor costs.
“Ultimately those borrowing costs are going to get passed along to tenants, and we don’t have particularly strong rental controls in Canada.
“[Homeowners] are highly incentivized right now to raise rents as much as they can … evictions are a consequence of that.”