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Mortgage trigger rate risk heightened if rates stay higher for longer

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Trigger rates on variable rate mortgages are in the spotlight as interest rates skyrocket. (Chris So/Toronto Star via Getty Images)

Experts warn that if interest rates stay high for longer amid stubborn inflation, more and more homeowners will be at risk of trigger rates that raise their monthly mortgage payments.

“Mortgage default risk from resetting trigger rate payments should be contained unless inflation rises further. united nationsMortgage expert and Mortgage Logic editor Rob McLister said in an email: Yahoo Finance Canada.

“No one can say the topic is overstated because you never know what’s going to happen next.”

A variable rate mortgage typically has a fixed monthly payment, and as interest rates rise, less of that payment is returned to the principal. If interest rates spike, some homeowners may see their payments hit the trigger rate. The trigger rate is the point at which the interest portion due is higher than the payment itself.

When this happens, lenders give homeowners several options, such as raising their entire monthly payment to cover at least the interest portion, extending amortization, or requiring a lump sum payment to reduce the loan principal. We can provide.

Canada’s largest bank says the majority of its mortgage customers can afford rising monthly payments, but McLister said some homeowners could be in financial trouble. Stated.

If the Bank of Canada raises the base rate by another 1%, “it will wipe out a good chunk of households,” he said. He added that another 2% rate hike would be “devastating” and lead to a deeper recession.

The biggest risk, according to McLister, is if the market is underestimating inflation and the Bank of Canada needs to raise its key rate significantly above 4.25%. Overnight swap data now shows that the market expects the overnight rate to reach 4% by the end of the year, from just 0.25% in March.

“A significant minority of variable rate mortgage holders will have negative monthly cash flow if rates are increased by more than 400 bps. Perhaps regulators will formalize industry-wide policies that allow, for example, deferred write-offs,” he said.

gradual problem

“It really depends on where interest rates go. , will be a greater risk,” says Mike Rizvanovitch. said an analyst at Keefe Bruyette & Woods. Yahoo Finance Canada in a telephone interview.

Royal Bank of Canada said on its third-quarter earnings call in August that about 80,000 mortgages are expected to reach the trigger rate “within the next few rate hikes.”

“The average markup is about $200.

In an August conference call with Toronto-Dominion Bank analysts, the bank said floating-rate borrowers who deviate from their mortgage amortization schedule should adjust their payments at renewal to bring them back to their original amortization date. I got

“One of the things people sometimes misunderstand about Canadian banks is that if you don’t pay your mortgage, they’re just a mean monopoly that will come to you and kick you out of your house. Really not, they will work with you and explore different avenues to avoid being forced into bankruptcy, because owning a bunch of homes and trying to sell them at a potentially steep price is not an option for them. This is because it is not profitable for

But a major factor in whether banks will work with borrowers is their ability to make monthly payments on time.

“They will see your ability to carry that debt. is only an individual.

Sticker shock at the time of renewal

Rizvanovic said rising mortgage rates will become a more pressing issue over time due to disruptions in housing activity during the pandemic when interest rates were ultra-low.

Using data from Statistics Canada, the Bank of Montreal previously said 60% of new mortgages will have floating rates as of December 2021.

“If you’re talking about renewal sticker shock, a lot of it will come in 2024 and 2025, given the typical time period people take out mortgages. Late 2020 and most likely 2021. So basically three, two, three years from now they won’t see the pain,” Rizvanovic said.

Banks vs Alternative Lenders vs Private Money

According to McLister, Canada’s largest bank manages four-fifths of mortgages, or about 1.6 million mortgages. He estimates that at least 350,000 customers will be able to activate the trigger rate if the benchmark interest rate hits 4%, as the market expects.

But bank mortgages have historically shown resilience in times of economic stress, as banks dominate the traditional lending market.

“Historically, the mortgage books have never been a direct credit loss problem. It’s not directly related to our portfolio, which is usually other unsecured things like credit card debt or car loans,” Rizvanovic said.

He added that the main risk from rising interest rates over the long term is the hit to consumer spending and its impact on the domestic economy.

Alternative lenders, such as Home Group and Equitable Bank’s parent company, deal with many non-prime borrowers, but these lenders remain regulated, reducing mortgage risk, he said. rice field.

Homebuyers who do not qualify for loans from regulated lenders may turn to the riskier private lending market.

Private lenders consist of small businesses and wealthy individuals who finance mortgages and operate outside of regulated financial institutions. Loans are typically short-term, have much higher interest rates, and can have a higher ratio to the value of the loan. Also, since this market is unregulated, it is much less transparent.

“That’s generally where most of the risk resides. If you think about the big six Canadian banks, they don’t do non-prime lending on mortgages. I mean, they don’t do it at all.” The method of calculating debt service capacity is very rigorous,” says Rizvanovic.

Michelle Zadikian is a Senior Reporter at Yahoo Finance Canada. follow her on her twitter @m_zadikian.

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