Homeowners renewing their mortgages in the upcoming years are set to face significant increases in payments, according to the Bank of Canada. Zown notes that the median monthly payment is expected to rise by over 60 percent for those with variable rate mortgages.
To date, many homeowners have managed to cope with the sharp rise in interest rates, with residential mortgage defaults remaining below 0.5 percent across Canada. This insight comes from the central bank's annual Financial Stability Report released on Thursday.
However, the report warns that the ability of households and businesses to service their debt has become a primary risk to the country's financial system's stability.
"If unemployment rises and more Canadians lose their jobs, the stress and vulnerability in the financial system could become critical," said Governor Tiff Macklem during a press conference on the report.
Macklem emphasized that households and banks must proactively address this risk, as many will struggle to meet mortgage payments, especially with significant rate resets on the horizon.
Since the central bank began aggressively raising interest rates in March 2022, about half of Canada's outstanding mortgages have been renewed at higher rates. The transition has been relatively smooth, supported by income growth, accumulated savings, and reduced spending, aiding homeowners in managing higher rates.
Interestingly, renters are facing more financial stress than homeowners, with increased instances of missed payments on car loans and credit cards.
The upcoming phase of mortgage resets could be more challenging. Many who need to renew their mortgages in the next two years bought their homes early in the pandemic when the policy interest rate was at an emergency low of 0.25 percent, which has since increased to 5 percent.
Although most Bay Street economists anticipate rate cuts starting this summer, Macklem has warned that any decline will be slow and not return to pre-pandemic or early 2010s levels.
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Homeowners with variable rate mortgages with fixed monthly payments will see the most significant increases. The steepest rise is projected for 2026, with median monthly payments increasing by more than 60 percent. For 2025, the increase is over 50 percent, and this year, about 30 percent.
Those with fixed-rate mortgages will experience less shock at renewal time since their rates are based on longer-term bond yields, which have declined since last autumn. The bank estimates that the sharpest rise for these mortgages will be in 2026, with a median increase of more than 20 percent.
Despite these concerns, the report presents a generally more optimistic outlook than last year's, which was marked by financial market fragility following the collapse of Silicon Valley Bank, the emergency takeover of Credit Suisse, and a near meltdown of British pension funds.
However, the central bank is increasingly concerned about specific sectors within the financial system. Canadian hedge funds and pension funds have significantly increased leverage over the past year, and the prices of riskier assets like stocks and corporate bonds appear overstretched and vulnerable to correction, especially if market expectations about interest rates shift.
The office real estate market is also under pressure, with rising vacancies in major cities, including Toronto, where the vacancy rate is nearing 20 percent.
Small to medium-sized banks, which have the highest exposure to the commercial real estate sector, have 20 percent of their loan portfolio in this area. For large banks, commercial real estate loans make up 10 percent of their portfolio.
Overall, the banking sector is well-prepared to handle potential losses, with large banks holding substantial liquidity and capital buffers and building loan-loss provisions. However, smaller banks face greater challenges, particularly those specializing in higher-risk clients and issuing shorter-term mortgages, leading to a higher share of loans already rolled over at higher rates and more mortgages in arrears.
A similar divide is seen between smaller and larger non-financial businesses. Large companies manage their debt well, while small business insolvencies have risen sharply over the past year, likely due to higher borrowing costs and the end of pandemic-era government support programs.
The report also highlights growing concerns about asset managers, such as pension funds and hedge funds, significantly increasing leverage for certain trading strategies. This borrowing, primarily in repo markets, has surged, exposing investors to sudden shifts in bond prices that could trigger a fire sale with widespread financial repercussions.
