© Reuters. FILE PHOTO: A sign is seen outside the Bank of Canada building in Ottawa, Ontario, Canada, May 23, 2017. REUTERS/Chris Watty
Posted by Nivedita Balu
TORONTO (Reuters) – The Bank of Canada’s rate hike on Wednesday and the prospect of further increases raised risks for mortgage lenders as homeowners are likely to remain in debt for longer as they struggle to make higher payments or even pay off the interest portion of their loans. real estate. investors and analysts say.
After urging lenders to address risks from a sharp rise in borrowing costs, Canada’s main banking regulator, the Office of the Superintendent of Financial Institutions (OSFI), on Tuesday proposed tougher capital rules for lenders to prevent consumers from defaulting or entering negative amortization.
Negative amortization occurs when home loan customers’ variable monthly repayment payments are not sufficient to cover the interest component of the home loan. Which means that the excess amount is added to the outstanding loan, thus extending the repayment period.
“It’s all in the realization that there is pressure in the system,” said Greg Taylor, chief investment officer at Purpose Investments.
“There is definitely more danger because any time you hike you never know when it will be the straw that breaks the camel’s back.”
Unlike the United States, where homebuyers can take out a 30-year mortgage, Canadian borrowers are required to renew their mortgages every five years at prevailing interest rates.
On Wednesday, the central bank scaled back its forecast for inflation to reach its 2% target for the six months to mid-2025, in a sign that interest rates are likely to remain high for longer.
The cost of a floating-rate mortgage has now increased by about 70% of loans since October 2021, when interest rates hit a record low, prompting more than half of homebuyers to take out floating-rate loans. Analysts estimate approximately C$331 billion ($251 billion) of mortgages to be renewed in 2024 and C$352 the following year, highlighting the massive challenge of refinancing.
Certainly, thanks to strong hiring and stress testing at a higher rate, consumers can largely make their payments right now.
Low mortgage defaults
The latest data released during quarterly earnings showed that mortgage delinquency for all banks was low.
Of the six big banks in Canada, Bank of Nova Scotia and the National Bank of Canada (OTC:) do not offer a mortgage extension, which means that the payment owed by the consumer goes up for every increase the Bank of Canada announces.
The two banks will be key to any early signs of stress as borrowing costs rise. Analysts also warn that the two banks risk losing share in the mortgage market because their products offer less flexibility.
Scotiabank said it has been working with clients one-on-one in the current rate hike environment. The National Bank did not immediately comment.
Bank of Montreal, CIBC, and TD Bank both allow negative amortization as interest rates rise.
According to Desjardins, more than three-quarters of people with variable rate mortgages have already reached the starting rate.
RBC, the country’s largest bank, does not offer negative amortization, said Mike Rezvanovich, an analyst at KBW, but variable mortgage customers have already seen payments increase by as much as 40% to cover higher interest rates. While the other three banks cut off their lenders entirely until the mortgage is renewed.
RBC did not provide immediate comment.
The Canadian Banking Regulatory Authority’s latest proposal to increase capital requirements puts the most pressure on CIBC depending on how much the portfolio eventually moves into negative amortization, Rezvanovic said, adding that BMO and TD will experience a “very manageable impact.”
CIBC did not immediately comment.
One of the key factors to “keep demand going is mortgage tolerance,” said Darcy Briggs, portfolio manager at Canada’s Franklin Templeton.
Briggs added, “If your monthly payments don’t change, consumer behavior doesn’t change, so spending habits and patterns don’t. So it works the opposite of what the Bank of Canada is trying to accomplish.”
($1 = 1.3181 Canadian dollars)