There could be rough seas ahead as a wave of mortgage renewals amid high borrowing costs is set to wash over Canadian households and financial markets over the next 18 months, warns Canada’s banking regulator, the Office of the Superintendent of Financial Institutions (OSFI). In its Annual Risk Outlook report, OSFI says, “Of the mortgages outstanding as of February 2024, 76% will be coming up for renewal by the end of 2026. Canadian homeowners who will renew their mortgages during this time period could potentially face a payment shock.” The ‘shock’ will be felt most by homeowners who took out their mortgages between 2020 and 2022 when interest rates were much lower than today. “We expect payment increases to lead to a higher incidence of residential mortgage loans falling into arrears or defaults,” says OSFI in its report. “Mortgages that have already experienced payment increases due to renewal or product type, such as adjustable-rate mortgages, are already showing higher rates of non-performance.” Real estate markets across Canada have stabilized in recent months, as more buyers have emerged in response to an increase in listings, but OSFI says if those markets weaken, it could lead to a greater number of defaults as well as lower recovery rates and higher credit losses for financial institutions. Of most concern to OSFI are variable rate mortgages with fixed payments (VRMWP). “Some of these mortgages are negatively amortizing, meaning the scheduled mortgage payments no longer cover the full interest costs or the principal,” says OSFI. “In these situations, lenders offset the shortfall by increasing the remaining outstanding principal.” “While most institutions report the shortfall as extended amortization periods, the contractual mortgage term does not change unless and until the mortgage is refinanced.” What this means is borrowers with uninsured VRMFP will be confronted with higher outstanding principal balances, putting them at risk of experiencing a significant payment shock, says OSFI. “Borrowers have the option to make large lump sum payments or endure large monthly payment increases in the mortgage to return to their original contract term,” says the report. “Alternatively, if the circumstances warrant, borrowers can refinance their existing mortgage, however this may not eliminate monthly payment increases.” Canadian Mortgage Professional (CMP) reports OSFI has responded to the risks when it announced loan-to-income limits for uninsured mortgage portfolios that will help “prevent a buildup of highly leveraged borrowers.” “In March, OSFI confirmed that federally regulated banks will have to limit the number of mortgages that exceed 4.5 times the borrower’s annual income, or in other words those with a loan-to-income (LTI) ratio of 450%,” reports CMP. “We do not expect these limits to be binding under the current interest rate environment,” said OSFI, adding the limits are “supervisory actions” and that no additional details could be disclosed. “Additionally, OSFI said its decision in December to leave the minimum qualifying rate for uninsured mortgages unchanged at the greater of the mortgage contract rate plus 2% or 5.25% will ‘help ensure borrowers can still make payments if they experience negative financial shocks’” reports CMP. If mortgage rates remain elevated, the financial commitment required by borrowers to return to their contractual amortization (for example, lump-sum payment, mortgage payment increase) may put financial strain on many of those households,” OSFI said. Market watchers are leaning toward the Bank of Canada beginning to lower its overnight rate, which is 5%, at least once, if not twice between now and the end of July. The next Bank of Canada rate announcement is June 5 and then again on July 24.
