Shortly before the Bank of Canada announces another possible rate hike, variable-rate mortgage holders – one in three people in Canada – are worried. The situation will be catastrophic for many.
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With interest rates continuing to rise this year, homeowners with an adjustable-rate mortgage with fixed monthly payments should call their bank because they’re in for a surprise.
“I’ve been making monthly payments of about $2,900 on a remaining mortgage of about $500,000. I wasn’t really paying attention, my payments went through and that was it. But when I looked at my statements, I took the step,” said Jimmy Voyer, a resident of Chicoutimi.
“I realized that all the money I was spending every month was just going to interest payments and the balance wasn’t getting smaller. One day I received a letter saying that the interest was no longer even covered. My mortgage balance went up instead of down! I dug myself a hole,” he says.
So Jimmy decided to increase his monthly payments from $2,900 per month to over $3,800. “This means that at least my account balance drops a little every month,” he says.
The best investment
Geneviève Meunier and her partner experience a similar story. With a variable-rate, fixed-rate mortgage, they began to realize that their monthly payments no longer even covered the interest on their mortgage. As a result, the amortization—the number of years remaining on the loan—increased instead of decreasing.
“Last time I checked, the payback period was 45 years… whereas not long ago I only had 15 years to pay off my house,” says Geneviève. The solution for the Saint-Jérôme couple was simple: get rid of the mortgage. “We have released the funds and decided to pay them in full. We still had to pay $125,000. It’s a big blow, but for us it was the best opportunity to make a very good investment!”
Banks in trouble?
Obviously, not everyone can get rid of their mortgage that easily. And banks across the country are now faced with more and more borrowers whose mortgage balances are growing instead of shrinking.
In Canada, 35% of mortgage loans have variable interest rates, according to analyst Ben Rabidoux, founder of analytics firm Edge Realty Analytics (province-by-province data is not available). And 80% of these adjustable rate mortgages have fixed monthly payments, meaning the payment remains the same regardless of whether interest rates increase. “Already there are many people who are not paying back enough to cover the interest and principal of their payments. “We talk about negative depreciation,” he explains.
Three Canadian banks – Bank of Montreal, TD and CIBC – told the Globe and Mail that 20% of their customers who have this type of mortgage with a total loan volume of $130 billion are seeing their mortgage balances go up every day, rather than down to go. All because their monthly payment is not enough to cover the interest on their loan.
This extends the loan term. The analysis house WOWA recently showed that mortgage repayments over 25 years achieve interest rates that are rarely found at many banks. TD and RBC are 48% and 43%, respectively. And at both banks, 23% of the owners have a residual amortization of more than 35 years.
A mortgage of… 135 years
The situation is worrying in British Columbia and Ontario. As TVA Nouvelles reports, due to increased interest rates, the owners’ payback period is extended to 90 years and sometimes even more. Analyst Rishi Bakshi shared one of these cases with Le Journal, where the term of the mortgage to be paid is now… 135 years.
“This is one of many cases that I am aware of,” he wrote to the Journal. These are mostly people who have bought in the last two to three years and have opted for variable rate, fixed payment mortgages,” he says.
If a very large part of the population is affected by this situation, it can pose a systemic risk for banks, notes Valeri Sokolovsi, assistant professor at the University of Alberta and recently at HEC Montreal. “I am sure that the banks’ risk managers and the central bank are monitoring this situation closely,” he said.