Canadian households could be shocked to find their mortgage costs going up as interest rates rise, cautions DBRS Ltd. in a new report.
Many Canadian borrowers have become accustomed to declining interest rates, which has generally resulted in lower payments when they renew their mortgage loans every five years. However, borrowers are now facing a new environment, with rates likely heading higher, the report says.
The Bank of Canada has raised its key rate by 50 basis points in the third quarter, and the yield on the Government of Canada five-year bonds is up 60 bps to 70 bps since the start of June. “Interest rates will likely remain relatively low, but households could be surprised if rates start rising more quickly than expected,” the DBRS report says.
It warns that “interest rate shocks for some Canadian households could be significant.” This could, in turn, impact the credit performance of mortgages, housing markets, consumer spending and the broader economy.
The impact of higher rates on households will likely impact mortgages that were originated in the last five years more than it will households with fewer years remaining on their loans, the report notes. “While a 100 bps increase in rates would mean about a 9% increase in payments, a 300 bps increase in rates would result in a much more significant 29% increase in payments for borrowers with 20 years of remaining amortization on their mortgages,” it says.
As well, recent home buyers in markets where house prices have been increasing rapidly, “may face greater risk, as their sensitivity to mortgage payment shock is higher than for earlier buyers,” the report adds.
Recent buyers in hot markets are “more likely to have high levels of debt to disposable income as they have stretched to buy in these more expensive housing markets. This leaves them with less capacity to absorb increased monthly payments,” the report says. They will have experienced less appreciation on the value of their houses, leaving them more vulnerable to a sharp correction in housing prices, it adds.