Written by Breck Hapner
A new report from Royal Bank of Canada Capital Markets is suggesting that homeowner mortgages may be in trouble in the coming months, affecting Canada’s financial and housing markets. That report, along with concerns about variable-rate mortgages with fixed payments, have prompted Bank of Canada (BOC) Governor Tiff Macklem to call for a pause to reevaluate the situation. This move, a shift from his previous statements and stance, suggests that interest rates might decrease before Canada hits the two-percent inflation target.
This significantly factors into the current mortgage shock issue, as potential buyers will now have some foresight regarding what to expect from the BOC before investing in a mortgage. That being said, the process may be more difficult for some specific buyer demographics, according to Paterson, as “increasing immigration levels in the face of rising interest rates will result in a volatile Canadian housing market over the next few years.”
According to an October 30th Bloomberg article, the RBC Capital Markets report states that “payment shocks from mortgages renewing at higher interest rates over the next three years may pose a substantial tail risk to Canadian banks,” and “60 per cent of all outstanding mortgages with Canadian chartered banks will be up for renewal during the next three years.” This makes sense, considering that most homeowners possess five-year renewable mortgages, so in any given year, 20 percent will be eligible for renewal.
The BOC’s primary concern is that these renewals at drastically higher interest rates will result in the aforementioned “payment shock,” making existing homeowner mortgages considerably more expensive upon renewal. The report forecasts that there will be a 32-percent payment shock for those renewing in 2024. The BOC report predicts that the payment shock could be as high as 48 percent in 2026.
In the midst of historically low inventory, cost becomes a decisive factor, even if an applicable mortgage is secured. “The lack of inventory is exacerbating affordability issues,” Paterson said, “making it difficult for many residents to find affordable housing, particularly in cities with high demand and limited supply.”
What is most troubling about the BOC report is the fact that, according to the Bloomberg article, “the experts wrote they are not concerned about mortgage losses because mortgage delinquency rates and unemployment are currently below pre-pandemic levels.” In other words, at this point in time, the BOC doesn’t see an issue. Perhaps this is a calming tactic for exposed and vulnerable financial and housing markets. However, this is certainly going to change if interest rates remain high and unemployment continues to rise, leading to greater mortgage delinquency and affecting Canada’s major banks. The general principle is that as interest rates rise, the lead indicator is unemployment in shaping what happens next in the economy.
Canadian banks have stated that they are working to lower the impact of these shocks for homeowners possessing a variable-rate mortgage with a fixed payment. They are also trying to convince those without this type of mortgage to consider it for the sake of financial stability. That being said, there is a large number of homeowners who are not prepared for what is coming.
According to an October 30th Globe and Mail article, right on the heels of the BOC report coming out, Macklem suggests that the BOC “could cut rates before inflation reaches target.” Undoubtedly, this statement was designed to make homeowners feel better about the fact that their mortgages are coming up for renewal at considerably higher interest rates.
This doesn’t imply that Macklem expects Canadian interest rates to decrease in the near future. However, interest-rate increases generally take time to materialize. As a result, inflation could decrease, presenting opportunities to lower interest rates as inflation declines. If the momentum is downward, interest rates can be lowered simultaneously, aiming to stabilize inflation at two percent.
But there is still a great deal of uncertainty because the BOC made many inaccurate forecasts and predictions over the past two years. Housing market players have relied upon these misjudgments, leading to regrettable buying and mortgage decisions.
To counter a renewable mortgage with higher rates, Paterson recommends the following to buyers: “Getting pre-approved for a mortgage will help you understand how much you can borrow, making you a more attractive buyer to sellers. In a competitive market, you may need to be flexible with your preferences. Consider different neighbourhoods, property types, and even your must-have features. A local real estate agent can provide valuable insights and help you navigate the market. They can also assist in negotiating and closing the deal.”
The question arises: Will the economy remain stable so potential buyers can enter the Canadian housing market? If the BOC doesn’t do something to lower interest rates, Canada could experience a severe recession. The problem is that GDP in the U.S. is continuing to grow, and if Canada cuts interest rates, international money will flock to the U.S., generating a diminishing effect on the Canadian dollar, therefore, creating an entirely new set of economic problems.
Macklem not only has to deal with what is going on in Canada but also needs to manage whatever is happening south of the border. In an October 30th Bloomberg article, Macklem admitted that “fiscal and monetary policy are rowing in opposite directions.” That is, the efforts of the BOC to reduce inflation are affected by everything the federal government is doing with respect to spending.
The more money the federal government injects into the economy through spending and fiscal policy, the opposite effect is occurring compared to what the BOC’s interest rate increases aim to achieve. Therefore, high and sticky inflation is very quickly moving from a central banking problem to one that is being created and fostered by the federal government.
Government spending breeds more inflation, making the BOC’s job much harder while attempting to stabilize rates, uplift the housing market, and protect mortgage holders from impossible financial situations. It is no wonder homeowners are reluctant, if not downright refusing, to even consider selling their current homes.
Given these conditions and the potential challenges of renewable mortgages being impacted by much higher interest rates, what is the best and safest route for sellers who may be ready to enter the market?
“Understand your city’s current market conditions. Consult with a real estate expert in your area to learn more about properly pricing your home and the potential risks of overpricing,” Paterson said. “Be flexible with showing availability to accommodate buyer showing requests. Be open to negotiations and work closely with your real estate advisor to handle offers wisely.”
In our November recap, HAVEN will take a further look at the numbers: how Canada’s housing market is reacting to prevailing economic factors influencing real estate.