Canadian real estate has had an easy climb over the past 30+ years, but that might be coming to an end. That was the take from BMO Capital Markets in a new research note. Recent mortgage borrowers will have to renew at much higher rates in the future. The estimated renewal increase will be the largest since the 1980s. The bank warns a decades-long tailwind that boosted home prices has now reversed. Buckle up.
Bank of Canada Warns Recent Borrowers At Low Rates Will Pay More At Renewal
The Bank of Canada (BoC) Financial System Review warns mortgage rates are a financial risk. They argue households have only been able to manage their debt due to low rates. As mortgages renew at higher rates, the cost of debt servicing will rise. This is especially problematic for those who borrowed at artificially low rates recently. Despite being prepared with a stress test, concerns are widespread.
The BoC estimates mortgage rates will hit 4.5% in 2025/2026. At this level, they warn these borrowers will see payments increase between 24% and 45%, assuming all else is equal. That’s a big increase, but before we start weeping for these borrowers let’s give it a little context.
Remember, these borrowers took out debt at stimulus rates, below reasonable capital costs. Low rates were stimulus to incentivize borrowing to raise demand and inflation. The capital was basically on sale, as borrowers repaid less than inflation in many cases. They were stress tested for higher rates and should be capable of paying them. This isn’t a melt-down scenario but one where the risk is diverting capital from the economy.
Higher servicing costs divert capital from other areas. “[higher interest rates at renewal] will weigh on disposable income and increase vulnerability for more stretched households,” warns BMO
After all, paying more interest on debt is a similar impact to higher inflation. More cash is diverted from discretionary spending and funneled into smaller areas. The big difference here is no one needed to borrow, they received a discount to do it. Inflation on the other hand, has no opt out.
Canada’s Decades-Long Tailwind Boosting Real Estate Is Over
The overnight rate is still below January 2020, but higher renewals are here. “Note that, already today, those coming off fixed-rate mortgages from five years ago will be doing so with comparable rates already a good 2 ppts higher than origination,” says Kavcic.
As the above chart shows, an increase for mortgage renewals like this hasn’t been seen since the 80s. After a downtrend of nearly 40 years boosting prices higher, rates fell to nearly zero.
“Of course, there are ways to counter [increased renewals],” explains Kavic. Fixed-rate borrowers switching to variable rates or extended amortizations would help. However, that’s not the primary takeaway from the circumstances.
“The bigger point is that a decades-long tailwind of lower rates on renewal has reversed, at least for the duration of this cycle,” he warns.