Rate cut too little, too late to avoid consequences of Canadians’ high mortgage renewals says experts, Bank of Canada data

The Bank of Canada’s 0.25 percentage point interest rate reduction will have a minimal immediate impact on Canadians’ mortgage spending, but experts said increased spending on mortgages could seriously limit their discretionary spending and hurt the economy.

Last week, the Bank of Canada announced its first interest rate cut in four years to 4.75 percent. In July 2023, Canadian overnight interest rates rose to a high of 5 percent from 2020’s low of 0.25 percent.

The Bank struck out alone in its rate cut decision, as Canada’s labour market has tightened and inflation has moved back towards its target rate. Expectations are unanimous that the U.S. Federal Reserve will maintain its 5.5 percent interest rate this summer.

The majority of bank mortgage holders in Canada, who signed their first mortgage rates in or around 2020’s low policy interest rate, will renew with mortgage rates that are significantly higher.

“Even if it’s a quarter point, it’s not going to materially affect (the Bank of Canada), the macroeconomy, or even individual household decision making,” director of Canada economics at Oxford Economics Tony Stillo told The Hub, commenting immediately before the rate decision.

Nevertheless, given their impact on Canadians’ mortgage financing and the economy, Stillo said the Bank of Canada should be cutting its rates.

“We’ve been a little more bearish on the economy. There’s a softer patch to go through the middle of the year, and part of that is mortgage renewals at higher rates,” he said.

Because of the past year’s high interest rates, the median of all Canadian mortgage renewals will rise 30 percent by 2026. Canadians holding variable-rate mortgages with fixed payments are in the worst situation of all, with a median renewal increase of 60 percent the same year, according to the Bank of Canada’s Financial Stability Report for 2024, released last month. Nearly a quarter (23 percent) of Canadian mortgage holders have a variable rate while 69 percent are fixed, according to the Canadian Mortgage and Housing Corporation.

“The economy had been more vulnerable to high interest rates because of our high indebtedness of households and our heavy reliance on interest-sensitive housing,” explained Stillo.

Canadians with fixed mortgages secured over the past three years, when house prices peaked and interest rates were lower, will have their highest renewals this year, as interest rates are expected to drop further in months and years ahead, described Stillo. That’s why their payments will peak this year before declining.

Holders of variable mortgages are far worse off when it comes to future payment costs for two reasons. First, they’ve seen their payments rise with the soaring interest rate over the past four years. Second is negative amortisation accrued by many of those holders—a period of time in which interest payments are no longer enough to cover interest.

Rising interest rates have required variable mortgage holders with fixed payments to annually increase their fixed monthly payments, causing many to make insufficient payments resulting in negative amortisation.

In February, the Bank of Montreal, Toronto-Dominion Bank, and Canadian Imperial Bank of Commerce had a combined $94 billion of residential loans in negative amortisation as reported by the Globe and Mail. If not paid off monthly, their negative amortisation is added to their principal and drives up future mortgage renewals even further.

“If we see interest rates come down, that just means when they do renew, it’s that much more affordable,” said Stillo.

Likewise, the share of new mortgage holders whose payments require more than 25 percent of their income has risen significantly, along with interest rates, since the end of 2021.

In the fourth quarter of 2021, when the overnight interest rate averaged 1.5 percent, only 12.9 percent of new mortgages required that proportion of Canadians’ income. By the third quarter of 2023, while interest rates held at five percent, 34 percent of new mortgages required more than 25 percent of the mortgage holders’ incomes.

The negative effects of the past year’s interest rate climb are felt most intensely by low-to-medium-income households.

“They’re squeezed from higher debt service costs, they’re squeezed from higher prices and costs for goods and services…They may be living paycheque to paycheque already. And they’re ability to take on more debt is also more constrained,” said Stillo. He added the most dire cases of financial strain will see some selling their homes. The rising share of Canadians taking non-bank mortgages has rung similar alarm bells.

In the grand view, low-to-medium income mortgages could reach a combined $4 billion in 2024.

“That’s about half a percent of lower-income households current consumption,” said Stillo. In December 2023, private consumption accounted for 54.7 percent of Canada’s GDP.

“That’s one of the key drivers of why we think there’s going to be a shallow recession…weaker consumption,” he said.

Oxford Economics forecasts a moderate recession in the second and third quarters of this year. They forecast that the Bank of Canada will cut the policy interest rate to 4.25 percent by December 2024.

“Higher income households have the income capacity, excess savings from the pandemic, and the ability to take on more debt. So they can keep their spending profiles largely intact,” said Stillo. He said this will help them weather the coming year’s higher mortgage renewals.