Most Canadian Mortgage Borrowers Are Choosing Higher Interest Rate Risk Exposure

Canadian mortgage borrowers still in the market aren’t worried about higher interest rates, apparently. Bank of Canada (BoC) data shows new mortgage loan annual growth was negative in December. The majority of the remaining activity was issued with variable interest rates. It might not be obvious, but variable mortgage costs are essentially a bearish bet on the economy. The only way these loans don’t rise in cost is if the economy is too weak to hike rates, or it double-dips into a recession. It’s a bold call, at odds with expert forecasts.

Most Canadian Mortgage Borrowers Want Variable Interest Rates

New mortgage loans are falling, but most of the remaining debt has a variable interest rate. The outstanding mortgage debt balance reached $38.8 billion in December, down 18.7% from a year before. Of that debt, lenders issued 54.5% with variable interest rates — a record. People are either blinded by lower initial costs, or see a weak economic outlook. The only reason not to raise rates and tackle rising inflation is if the economy is too weak to handle it. That take would be a bet against the consensus, and even the BoC. 

Share of Canadian Mortgage Debt With Variable Rates

The share of Canadian mortgage dollar volumes issued with a variable interest rate.

Source: Bank of Canada; Better Dwelling.

Most Uninsured Mortgage Debt Had Variable Interest Costs

Uninsured mortgage debt represents the lion’s share of the total mortgage market. In December, lenders issued $32.6 billion in uninsured mortgage loans, down 12.2% from a year before. The majority (58.1%) was issued with variable interest rate terms, just under the Aug/Sep 2021 peak. Uninsured loans require more equity than insured loans and group together larger loans. Paying a few extra basis points might now be seen as insurance against higher rates.

Share of Canadian Mortgage Debt With Variable Rates By Segment

The share of Canadian mortgage dollar volumes issued with a variable interest rate.

Source: Bank of Canada; Better Dwelling.

Canada’s Insured Mortgage Borrowers Dropped Out of the Market

Insured mortgages, where buyers put less than 20% down, remains mostly fixed rate debt. In December, lenders issued just $6.2 billion worth of insured mortgage loans, down 41.0% from a year before. Lenders gave 35.7% of mortgage debt with variable terms, also just under the Aug/Sep 2021 record high. There’s a lot less incentive to go variable with insured rates, as the fixed term costs are already rock bottom. Saving a few minor points doesn’t make sense if you see rising rates.

Variable rate mortgages offer a lower initial rate, but exposes the borrower to rate hikes. The concern of whether borrowers can pay the rate hike should be nearly non-existent. In Canada, borrowers at the vast majority of lenders are “stress tested” to pay much higher rates. Interest rates can rise as much as 2 points and not put a dent in repayment ability. 

The concern with rising variable rate debt is largely due to savings. Many people think they’re saving a bundle by opting for variable rates, but might not. If the economy is healthy and rates rise to tackle inflation, any savings may disappear fast.

12 Comments

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  • Trevor 9 months ago

    Anyone else notice the discount on fixed rates is huge at the lender, but variable is just the cost offered?

    • Brandon 9 months ago

      Fixed debt pre-payment penalties are based on the posted rate, not the discounted rate. It’s so they can rip off homeowners who move within the fixed rate period.

  • Frank Daugherty 9 months ago

    Canada is the only place where people invest in housing because they think the economy is going to crash. LOL.

    • Doomcouver 9 months ago

      Considering our housing market has sidestepped multiple financial catastrophes as prices were shooting straight up I guess it’s logical in a weird way to keep investing. The problem is it’s intrinsically unsustainable and it’s tantamount to gambling.

      Investors should care more about diversification. Sadly many are content to pile 100% of their capital into dead-money real estate.

  • Lou Chao 9 months ago

    Gov keeps low rates so they can “borrow so you don’t have to,” and ignores “high inflation means you’ll have to borrow as well”

    • Doomcouver 9 months ago

      Yeah the Canadian government should have taken the bitter pill and allowed the pandemic to pop long-standing asset bubbles in this country. Now the bubbles are bigger, and the pressure to raise interest rates has never been higher. Now, instead of a short but rapid correction from the pandemic, we’re risking a slow, disorderly unwinding as rates begrudgingly rise at the BoC.

  • Charles D Flynn 9 months ago

    I am afraid it is not the lack of “fear” of higher rates that are driving the market, it is the fact that they can only qualify with the lower rates at present. It is the reality of the moment, just like the BoC throwing caution to the wind on inflations, everyone is living in the bubble mentality. They simply cannot help themselves after being led to water by the lack of leadership of the Central bankers and Government ministers they are more than willing to drink the Kool-Aid.

  • Arthur 9 months ago

    Ukraine is all important now.
    Therefore BofC will have little intention to raise interest rates.

    • Jeff 9 months ago

      You might be right, but inflation is probably going to be even more insane. We’ll see what happens.

  • Shane-O-Mac 9 months ago

    Forgive me for asking this –

    For insured mortgages, the lender is insured in the event of default by the borrower and paid by the borrower.
    For uninsured mortgages, the interest rates are higher for the borrower, but is this the only downside – in the event of default?
    Is the lender then “on the hook” for the uninsured loan, and/or can the lender then take losses from the defaulted borrower?
    Unless I am missing something, it seems there would be very little accountability in the event of a downturn or worse. 🤔

    • Mortgage Guy 9 months ago

      Pretty much nailed it with some small details.

      An insured mortgage insures the lenders for losses. A loss would be whatever the mortgages is minus whatever can’t be recovered by taking the house and disposing of it. So if a property sells for $900k, and the mortgage owing was $1M, the insurer would provide the $100k gap. Not a big issue as these levels, but they’re cheap because the gov backs them so there’s no risk.

      Uninsured mortgage is more expensive because of no insurance but the odds of losing money are slim. The home has 20% equity minimum and an average of 35%. For a loss to occur, the house would have to drop 20% or more and person would have to not pay the whole time. It happens, but it’s pretty rare.

  • Damian 9 months ago

    What if those who were were suppose to be stress tested, really were not, and their mortgage was pushed through to keep the economy moving? Could be a bigger problem than expected if rates move up even a small amount.

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