Mortgage Debt in Canada Is Soaring. That’s No Reason to Panic

Reasons to worry

When Canada’s housing market was set adrift at the beginning of the COVID-19 pandemic, low interest rates were expected to be the tugboat that guided it toward calm waters. It only took a few months before consumers piled on and drove up home values.

But today’s low interest rates cannot last. The Bank of Canada has already hinted it could raise its overnight rate from an all-time low of 0.25% — where it’s been sitting since being lowered twice in March 2020 — in the latter half of 2022. Once interest rates start climbing, the fear is that the cost of borrowing will shoot up and countless Canadians will no longer be able to carry what are currently affordable mortgages.

One expert ringing the rate-shock alarm is CIBC deputy chief economist Benjamin Tal.

Because of Canadians’ high levels of non-mortgage debt, $783 billion and counting in April according to StatsCan, Tal feels homeowners are highly sensitive to the risk of rising interest rates. He estimates a 1 percentage point interest rate increase today would have the same impact on consumers that a 2-point increase would have had two years ago.

Homeowners with no room in their budgets for a 1-point increase in their mortgage rates will certainly have challenges affording a growing mortgage.

But how many Canadians will be in that situation when interest rates do rise?

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Reasons to breathe easy

There are at least four reasons to believe that Canadians will be able to continue making their mortgage payments, even if rates rise.

1. High underwriting standards among Canada’s lenders

When most Canadians think of a housing crash, they recall the U.S. market collapsing during the 2008 financial crisis. That’s not likely to happen in Canada.

Canada’s lenders are famously conservative. If a buyer doesn't present the right balance of income, debt and creditworthiness, a mortgage with a reputable lender doesn’t make it over the finish line.

America’s pre-crisis housing frenzy occurred because of a lack of lending standards. NINJA loans — no income, no job or assets — were not only common, but encouraged by some lenders looking to funnel subprime loans into an opaque mortgage-backed securities system where bad mortgages could make for profitable business.

Tacit acceptance of those practices at the regulatory level does not exist in Canada. Our lenders apply standards which govern the majority of mortgages that get approved here.

2. The stress test

While despised by many of Canada’s first-time homebuyers, the country’s mortgage stress test is another powerful hedge against borrowers winding up underwater.

As of June 1, loan applicants must be able to prove they can afford an interest rate of 5.25% to have their loans approved, regardless of the mortgage rate they're offered by their lender.

Mortgage rates today are nowhere near 5.25%. Five-year, fixed-rate products are hovering around 2%, while five-year variables are in the 1.5% range. If the stress test is accurate, recent borrowers would have to see their interest rates more than double before finding themselves in financial jeopardy.

There’s a reason that’s not likely to happen.

3. The Bank of Canada won’t rush to raise rates

Tal’s interview with BNN this week got pulses racing when he said a rapid increase in interest rates from the Bank of Canada “would be devastating for the housing market.”

It’s safe to assume the Bank of Canada, which manages the health of the entire economy, is aware of this. A rapid run-up in the overnight rate wouldn’t just destabilize the housing market, it could derail Canada’s economic recovery from COVID-19 by suddenly increasing the cost of borrowing for everyone.

“The hope is that they will move early, and slowly, and by doing so, you actually limit the damage in the mortgage market and the housing market,” Tal said. “I think that the fact the Bank of Canada is telling us that they will be moving in the second half of 2022, which is much earlier than expected just a few months ago, that’s a very positive sign.”

4. Most Canadians have fixed-rate mortgages

Recent homebuyers who opted for variable-rate mortgages could indeed face discomfort when rates start rising.

But Canadians overwhelmingly choose fixed-rate products. In its Annual State of the Residential Mortgage Market in Canada for 2020, Mortgage Professionals Canada found that 77% of the mortgages taken out last year involve fixed-rate products. Variables accounted for only 18%. The remaining 5% were combination mortgage products.

That means almost 80% of 2020 homebuyers won’t be affected by a rate increase until the end of their mortgage terms. With most fixed mortgages in Canada lasting for five years, that gives homeowners plenty of time to build up equity in their rapidly appreciating homes.

The Canadian Real Estate Association projects a 19.3% increase in the average home price in 2021. In its most recent Housing Market Outlook, Canada Mortgage and Housing Corporation expects home prices to continue increasing in every major Canadian market through 2023.

If homeowners are unable to maintain their payments once their mortgage terms are up, they should be able to sell and walk away with their finances — and financial futures — intact.