While many homeowners will face payment pressure when renewing their mortgage at current higher rates, variable-rate borrowers renewing for the first time will experience the biggest shock of all, according to new analysis from Desjardins.
That’s because these mortgage holders will have to make one of two choices if they hope to pay off their home in the same timeframe: hike their monthly payments by more than 30 per cent so their their current amortization period doesn’t extend, or come up with a massive lump sum, as much as $160,000 in some cases, to put towards the loan.
“Borrowers can make a lump sum payment at renewal to reduce the payment shock. But our simulations find it’s currently taking a lump sum payment equal to roughly 20% of the original loan value to keep the payments unchanged,” Royce Mendes, managing director at Desjardins and lead author of the report, said on Monday.
“To put that in perspective, a first time homebuyer who purchased a house in 2018 for $1,000,000 and put $200,000 down would need to put up another $160,000 to keep their monthly mortgage payment steady.”
There are likely some homeowners who have no idea what type of payment shock they could be in for.Royce Mendes, managing director, Desjardins
These are extreme examples, he notes, but they demonstrate how higher rates have affected some homeowners, especially those who bought recently and have much less equity built up.
“Our simulations show how vulnerable some homeowners will be when it comes time for renewal. There are likely some homeowners who have no idea what type of payment shock they could be in for,” he told Yahoo Finance Canada in a separate written response.
Mendes says he suspects many homeowners will resort to some combination of higher payments and a lump sum upon renewal to keep the loan in check.
“But any way you slice it, there will be pain, particularly if rates don’t fall as much as we forecast,” he said in the report.
Desjardins expects the Bank of Canada to hold its benchmark rate steady at 4.50 per cent rather than hike one more time in the summer as some economists predict.
Not on the ‘verge of catastrophe’
The rapid rise in interest rates has created difficulties for mortgage holders, but lenders have taken some “unusual” and even “surprising” measures to help limit potential risks, Mendes says.
For example, banks are allowing mortgage amortizations to extend well beyond the 25-year limit or letting the mortgage balance grow, a sign that borrowers can’t make the full interest payment and it is being added to the principal loan.
Canadian regulators are keeping a close eye on financial system vulnerabilities and have proposed some tougher rules such as higher capital requirements against these mortgages, but have so far not taken drastic steps to intervene in these looser lending practices.
“None of this is to say that Canada is on the verge of catastrophe; certainly not the housing market, which should continue to be supported by strong population growth. Relative to the US right now, there’s less of an inflation problem, a more resilient banking sector and no debt ceiling shenanigans,” Mendes said.
“But mortgage renewals are counting down in the background. Borrowers can use a combination of mitigation strategies to deal with the shocks. However, those are not foolproof and the market seems yet to catch on to the complications the Canadian economy will face.”
Michelle Zadikian is a senior reporter at Yahoo Finance Canada. Follow her on Twitter @m_zadikian.
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