Canadian Uninsured Mortgage Borrowers Risking Payment Shock Is Surging

More Canadian mortgage borrowers are betting the economy won’t get much better. At least, they’re unintentionally placing that bet with their mortgage borrowing terms. Data from the Bank of Canada (BoC) shows big growth for uninsured mortgage credit extended in April. It actually saw the largest annual growth on record, driven by a surge in variable rate mortgages. With experts seeing higher rates in the future, this can leave borrowers paying a lot more. It now makes a little more sense why the bank regulator tightened the stress test.

Uninsured Mortgages and Variable Rates

If you’re well versed with mortgages, feel free to skip right to the data. If you’re new, or need a refresher, let’s quickly go over uninsured mortgages and variable rates.

Uninsured mortgages are loans that, well, can’t be insured by the bank. These borrowers need a downpayment of at least 20%, and it’s mandatory for homes over $1 million. If the borrower stops paying, the mortgage lender has equity they can go after. The odds of a lender losing money is slim, but it’s not non-existent, like with an insured mortgage. Borrowers tend to pay higher rates for the lack of insurance. Though they save thousands by not having to buy the bank any mortgage insurance.

Variable rate mortgages are what they sound like — a mortgage where the rate changes. As interest rates fluctuate, so does the mortgage rate during a borrower’s term. This is in contrast to a fixed-rate mortgage, where the rate is the same throughout the term. People tend to choose variable rate mortgages because they’re cheaper when signing up. They only remain that way if the economy doesn’t improve during their term though.

Mortgage payments with variable rates generally don’t change in size during the term. If the mortgage rate falls, more of that payment is applied to the principal. This helps to accelerate paying off that loan. Rates generally only fall in a worsening economic environment though. Betting that rates will fall or stay the same, is generally placing a bet that things are as good as it gets. 

If rates rise, a variable mortgage sees less money applied to the principal and more to interest. This can leave the borrower paying a lot more interest, and their debt can persist for longer. Mortgage rates doubling in the past was unlikely, but going from 1.5% to 3.0% isn’t all that far-fetched now. If that happened mid-term, a borrower would pay almost $2 in interest for every $1 applied in principal. That would suck royally.

Canadian Lenders Extended 36.6% More Uninsured Mortgage Credit

Uninsured mortgage borrowing showed a monthly decline, but very large annual growth. Lenders extended $40.4 billion of uninsured mortgage debt in April, down 5% from the month before. Annual growth still came in at 36.6%, which is a very high level of growth — but tapered from the peak annual growth in March. It wasn’t just a base effect either. The same month last year reported over 40% growth, which is amongst one of the highest annual rates in the past decade.  

Canadian Uninsured Mortgage Credit Extended

The 12-month change in growth for the total of uninsured mortgage credit extended per month..

Source: Bank of Canada; Better Dwelling.

Breaking that down, fixed-rate mortgages with terms of 5-years or longer was a big chunk. Lenders extended $12.8 billion with these terms in April, down 22.6% from the month before. Annual growth still came in at a healthy 11.7%, but that’s about a third of the total rate of growth. Typically fixed-rate mortgage debt with terms longer than 5-years dominates lending. If you’re borrowing a lot, you want a little predictability in your payments.

Variable rate mortgage credit was the big driver for the month though. Lenders extended $16.2 billion in April, up 23.6% from the month before. Annual growth came in at a whopping 100.3%, doubling the amount extended last year. More people, or at least larger borrowers, are betting rates aren’t going anywhere. That or the economy will get worse than it currently is.

Canadian Uninsured Mortgage Credit Extended By Segment

The monthly dollar value of uninsured mortgage credit extended for variable rate, and fixed rate mortgages, with a term of 5 years or longer.

Source: Bank of Canada; Better Dwelling.

If you missed that, lenders are extending more in variable loans than fixed, but with longer terms. Variable rates represented 40.1% of the total uninsured mortgage credit extended. Fixed rates with terms 5 years or longer represented just 31.7% — the smallest share since June 2019. This is unusual, with fixed terms 5-years or longer typically being the largest share.

The last few times this inversion happened, mortgage creep appeared after the flip. The average variable rate extended shows a steady climb after it happened in June 2019. Variable rates increased by more than the amount they saved opting for a variable mortgage. They would have paid a lot more if it weren’t for one tiny hiccup — the pandemic. Rates plummeted in March 2020, after climbing right up to the month before.  

Most economists and experts see mortgage rates rising over the next few months. Some see very large increases coming, even before the overnight rate. It appears many households aren’t taking to that narrative, and are betting on QE-level rates persisting  in the future. That’s a lot of stimuli they’re betting on, possibly requiring a double-dip recession.

Ironically, those bullish on real estate are bearish on the economic environment. Now it makes sense why the regulator tightened the stress test, and lowered liquidity. They’re fine if borrowers enter a debt situation where the terms are looking worse. They just need to make sure a borrower can continue to honor those terms.

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  • Omar 3 years ago

    I don’t think many people understand QE was meant so people can lock in long-term rates , in exchange for higher inequality. They probably think the low rates are low, because interest rates aren’t going anywhere.

    Few people get the government is spending like a drunken sailor because they’re worried the Canadian dollar will get too strong with the commodity climb.

    • Paul 3 years ago

      Omar, cart before the horse on your last line there.

  • Smaug 3 years ago

    Question: I see a lot of ads for variable rate mortgages for a 5-year term. Does that mean they lock you into a VRM for a full five years? And you can’t lock into a fixed rate for that entire time, regardless of how much rates rise?

    • Mortgage Guy 3 years ago

      Some (not all) allow you to convert to a fixed. You’re still paying a premium for a fixed rate, you’re just hoping the premium isn’t eaten up by rising rates.

      5 years is a long time in this environment for a variable. Just my two cents, but people shouldn’t forget they can take out shorter terms. It doesn’t need to by variable or 5 years. Last year was probably one of the best deals you’ll ever get for a 5-year fixed rate though.

  • Travis Hunter 3 years ago

    People that think the economic impact of the pandemic is over are kidding themselves. The Great Recession was still being felt right into the pandemic. Job gains increased, GDP recovered, the stock market passed pre-recession levels and then some, but the distribution was very different.

  • Pepp 3 years ago

    Do you realize that currently for prime borrowers the variable rate is prime rate minus 1-1.5% which works out to approximately 1.5-2%. And borrowers can lock into fix rate anytime. These people are not being “screwed” even if rates increase 2%. They been stress tested. However if the interest rate increase 2% now the economy will die before these borrowers.

    I dont think this article’s argument is a legit concern unless rates climb 4-5%. And that takes time, by the time their rates goes beyond 3% they would have locked in already.

    • Paul 3 years ago

      They will do a soft appraisal to switch. That means if fundamentals have changed enough they may not be able to.

      Every day we see a black swan where something we couldn’t have imagined happens.

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