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Renewal Redux – Assessing the Risk as Payment Shock Looms

14 November 2023

Earlier this month, the Bank of Canada voiced concern over variable rate mortgages. Worries stem from the growing balances some borrowers are facing in the wake of a rapid rise in interest rates. This so-called negative amortization occurs when interest costs exceed a borrower’s fixed mortgage payment, and the shortfall is added to the outstanding mortgage balance. 

Following the Bank’s caution, CMHC published a report providing specifics on the scale of upcoming mortgage renewals. According to the housing agency, in 2024 and 2025, approximately 2.2 million mortgages, valued at $675 billion, are set to renew. These borrowers are expected to encounter interest rate shocks, given that most closed their mortgages at historically low interest rates. This group represents about 45% of all outstanding mortgages in Canada.

CMHC’s analysis comes from Statistic Canada data which shows the outstanding stock of variable rate mortgages has been declining. This is to be expected as banks have been working with their borrowers to prepare for renewal by either switching to a fixed rate mortgage, or by using their prepayment privileges to pay down their mortgage balance.

A helpful way to gauge how borrowers might adapt to increasing payments is to examine the mortgage portfolios of Scotiabank and National Bank. In contrast to the other Big Six banks, both lenders provide variable mortgages with adjustable rates. This means that as interest rates fluctuate, the mortgage payments adjust to maintain a fixed amortization period. Based on reporting, there has been no significant change in the performance of these portfolios. Monitoring these portfolios can serve as an early indicator of how other mortgage borrowers might handle potential payment shocks. By all accounts, the other major banks have taken a proactive approach with their borrowers to prepare them for upcoming renewals.

Although discussions about upcoming renewals have primarily focused on variable rate mortgages, the majority of those facing a potential rate shock are fixed rate holders. When renewal time comes, these borrowers have several options:

  1. To brace for potential higher payments, borrowers can proactively incorporate the increased amounts into their current budgets. The stress test was specifically designed to ensure that borrowers can manage payment shock at renewal.
  2. Another option is for borrowers to explore a different interest rate that may better suit their financial circumstances.
  3. For those with insured mortgages who have been diligently reducing their principal through prepayments or accelerated payments, there is an option to renew at the original scheduled amortization rate. This lesser-known feature of their mortgage insurance policy allows borrowers to continue with their mortgage based on the original repayment schedule, providing flexibility in managing their financial obligations during renewal.

To better assess the risk, it would be helpful to understand the composition of this borrower group. Specifically, insights into the number of first-time borrowers with elevated debt-to-income ratios would provide valuable context. While one might anticipate income growth, it’s crucial to acknowledge that certain borrowers within this cohort may have encountered substantial declines in property values, particularly in markets where home prices surged by as much as 40%.

Secondly, it would help to know how many of these mortgages involved cash-out refinances. In such scenarios, borrowers refinance early at a higher mortgage amount and take the difference in cash, utilizing the home equity as collateral for the increased loan. Notably, the maximum loan-to-value ratio in these cases is typically 80% of the home’s value. With home prices down from their pandemic highs, borrowers who engaged in cash-out refinances might face limited options upon renewal, underscoring the importance of examining this aspect of the mortgage landscape.

Overall, there seems to be no significant stress in the market due to this wave of upcoming mortgage renewals. If borrowers do experience payment shocks, it is more likely that the impact will be seen in decreased discretionary spending rather than an increase in mortgage defaults.


Independent Opinion

The views and opinions expressed in this publication are solely and independently those of the author and do not necessarily reflect the views and opinions of any person or organization in any way affiliated with the author including, without limitation, any current or past employers of the author. While reasonable effort was taken to ensure the information and analysis in this publication is accurate, it has been prepared solely for general informational purposes. Any opinions, projections, or forward-looking statements expressed herein are solely those of the author. There are no warranties or representations being provided with respect to the accuracy and completeness of the content in this publication. Nothing in this publication should be construed as providing professional advice including investment advice on the matters discussed. The author does not assume any liability arising from any form of reliance on this publication. Readers are cautioned to always seek independent professional advice from a qualified professional before making any investment decisions.

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