How worried should variable-rate borrowers be about Bank of Canada rate hikes?

Skip to Content News Archives Economy Energy Oil & Gas Renewables Electric Vehicles Mining Commodities Agriculture Real Estate Mortgages Mortgage Rates Finance Banking Insurance Fintech Cryptocurrency Work Wealth Smart Money Wealth Management Investor Personal Finance Family Finance Retirement Taxes High Net Worth FP Comment Executive Women Puzzmo Newsletters Financial Times Business Essentials More Innovation Information Technology FP500 Podcasts Small Business Lives Told Tails Told Shopping Financial Post Store Obituaries Place a Notice Advertising Advertising With Us Advertising Solutions Postmedia Ad Manager Sponsorship Requests Classifieds Place a Classifieds ad Working Profile Settings My Subscriptions My Offers Newsletters Customer Service FAQ News Economy Energy Mining Real Estate Finance Work Wealth Investor FP Comment Executive Women Puzzmo Newsletters Financial Times Business Essentials This advertisement has not loaded yet, but your article continues below.HomeReal EstateMortgagesHow worried should variable-rate borrowers be about Bank of Canada rate hikes?Robert McLister: Here are four situations where policy tightening becomes a real problemWith the next central bank move likelier up than down, pick your floating-rate mortgage carefully, or avoid it altogether if you think the market is even half right about hikes. Photo by Blair Gable/PostmediaWednesday’s Bank of Canada announcement revealed policymakers may be more hike-prone than markets had assumed.THIS CONTENT IS RESERVED FOR SUBSCRIBERS ONLYSubscribe now to read the latest news in your city and across Canada.Exclusive articles from Barbara Shecter, Joe O'Connor, Gabriel Friedman, and others.Daily content from Financial Times, the world's leading global business publication.Unlimited online access to read articles from Financial Post, National Post and 15 news sites across Canada with one account.National Post ePaper, an electronic replica of the print edition to view on any device, share and comment on.Daily puzzles, including the New York Times Crossword.SUBSCRIBE TO UNLOCK MORE ARTICLESSubscribe now to read the latest news in your city and across Canada.Exclusive articles from Barbara Shecter, Joe O'Connor, Gabriel Friedman and others.Daily content from Financial Times, the world's leading global business publication.Unlimited online access to read articles from Financial Post, National Post and 15 news sites across Canada with one account.National Post ePaper, an electronic replica of the print edition to view on any device, share and comment on.Daily puzzles, including the New York Times Crossword.REGISTER / SIGN IN TO UNLOCK MORE ARTICLESCreate an account or sign in to continue with your reading experience.Access articles from across Canada with one account.Share your thoughts and join the conversation in the comments.Enjoy additional articles per month.Get email updates from your favourite authors.THIS ARTICLE IS FREE TO READ REGISTER TO UNLOCK.Create an account or sign in to continue with your reading experience.Access articles from across Canada with one accountShare your thoughts and join the conversation in the commentsEnjoy additional articles per monthGet email updates from your favourite authorsSign In or Create an AccountBond traders noticed the hawkish tilt instantly and priced a pre-Christmas hike as nearly a done deal.And forward rate data from CanDeal DNA implies four more hikes after that, 125 basis points of tightening in total.Needless to say, people eyeing a new mortgage would love to know how much potential hikes could cost them.And according to August data from Dominion Lending Centres Group, the nation’s largest mortgage originator and a company I’m affiliated with, over 56 per cent of their prime borrowers picked a variable anyway.SUBSCRIBER EXCLUSIVE: FP West: Energy Insider brings you behind the oilpatch’s closed doors with exclusive insights from insiders every Wednesday morning.By signing up you consent to receive the above newsletter from Postmedia Network Inc.A welcome email is on its way. If you don't see it, please check your junk folder.The next issue of FP West: Energy Insider will soon be in your inbox.We encountered an issue signing you up. Please try againTo size up that risk, picture a Canadian household that has the average:Mortgage balance of $293,270 (source: TransUnion)Remaining amortization of 19 years (the approximate industry average)Dual-earner full-time wages of $165,000 (source: StatCan weekly earnings)Non-mortgage debt load of $28,118 (source: TransUnion)Floating-rate discount of prime minus 0.80 per cent (which is 3.65 per cent today)Monthly mortgage payment of roughly $1,781That payment eats just 13 per cent of this “average” borrower’s gross income.Even if the Bank of Canada hiked the full 125 basis points the market is pricing in, someone with an adjustable-rate mortgage (ARMs) — the kind where payments rise when the prime rate rises — would see their payment climb to just $1,963.This would drain an extra $2,184 from their annual budget, though wages have climbed about 3.50 per cent annually over the last decade — $5,775 on that $165,000.So, net-net, the average borrower survives.But here are four situations where policy tightening becomes a real problem:#1 — If we see several more hikes than expectedIt’s possible that any hiking cycle proves mercifully short.The oil shock won’t last for years, with Iran’s economy on the brink of collapse; sanity may return to the White House in 2029 and AI should prove disinflationary in the end.Nonetheless, the future is murky, and the average tightening cycle has entailed roughly 11 quarter-point hikes, or 275 basis points (as measured during the inflation-targeting era).A 275-point climb drives up that payment 24 per cent, easily outpacing average wage growth.And in this author’s view, that’s the minimum a rate floater should brace for in a potential rate hike cycle.#2 — If you overbuyIf our theoretical couple maxes out their buying power, their $165,000 of income and $28,118 in non-mortgage debt support a $757,485 mortgage, including the default insurance premium.And note that 52 per cent of buyers paid the maximum they could afford, according to the latest Canada Mortgage and Housing Corporation data.This advertisement has not loaded yet.This advertisement has not loaded yet, but your article continues below.These folks have a smaller monthly cushion, so they need backup liquidity (assets) to justify pushing their debt limits.Without that backstop, a payment jumping 20 to 40 per cent stops being arithmetic and starts being insomnia.#3 — If you pile up debtPeople often don’t overbuy the house; they overbuy everything around it — hefty car payments, furniture on credit cards, a new pool, landscaping, vacations financed at 20 per cent, and so on.Once non-mortgage debt swallows your spare monthly cash flow, a floating rate stops being a strategy and becomes a dare.#4 — If your income stallsLayoffs, separation, self-employed business blow-ups, bonus cuts, surging inflation — there are all sorts of reasons a person’s disposable earnings could dive. Variable rates make folks more vulnerable to these shocks.And let’s not forget, rate hikes are designed to slow the economy. Much of the transmission mechanism runs through employment, which takes a hit when rates surge by 200 to 300-plus basis points.Product choice mattersIn the four scenarios above, a rate-hike cycle becomes much more unpleasant, making ARMs the wrong flavour of prime-linked mortgages.If you’re suited to floating at all and budget protection is the priority, take a VRM — a variable-rate mortgage — instead.A VRM holds your payment steady unless rates climb past the point where it covers all the interest.In such cases, most lenders, though not all, raise the payment to at least cover interest.Canada’s top bank regulator, Peter Routledge, has publicly knocked fixed payment variable rate mortgages (FPVRMs), partly because they quit amortizing when rates climb too high.Of course, that’s the whole point of a VRM: postpone principal to blunt the budget shock from surging rates, until rates ease or the borrower can refinance, sell or generate more income.Side note: If you don’t have 20 per cent equity or more, you generally can’t refinance. And if you’re underwater on the mortgage, you might not be able to sell.Worse yet, equity tends to shrink at exactly the wrong moment, since the same hiking cycle that raises payments usually softens prices. If all else fails, financially stressed borrowers can request payment relief from federally regulated lenders, who sometimes offer amortization extensions or payment deferrals.Routledge also cautions that FPVRM borrowers can face payment spikes at maturity, since lenders recover the skipped principal by hiking their payment at renewal.But an FPVRM at least hands you time to prepare for that, unlike ARMs, where hikes sometimes come out of the blue.Moreover, payment mitigation options do exist, and oftentimes rates simply fall because they’re cyclical, thus reducing payment pressure by renewal.All told, the knock on VRMs is overblown, and the last rate cycle was evidence.Despite the steepest hiking cycle in more than three decades (+475 basis points) and record consumer leverage, arrears still sit at just 0.29 per cent.The long-run average, according to Canadian Bankers Association data, is 0.35.Defaults stayed low even as over a million fixed-payment variable borrowers hit their trigger rates. Hence, VRM fear is barking up the wrong tree.Remember, too, that most borrowers must show they could handle the equivalent of at least eight quarter-point Bank of Canada hikes to even qualify for a floating rate. That, in essence, is the government’s mortgage “stress test.”All this is to say, with the next central bank move likelier up than down, pick your floating-rate mortgage carefully — if you get one — or avoid it altogether if you think the market is even half right about hikes.Robert McLister is a mortgage strategist, interest rate analyst and editor of MortgageLogic.news. You can follow him on X at @RobMcLister.For the best national insured and uninsured mortgage rates, updated daily, please visit our mortgage rate page here.We apologize, but this video has failed to load.Notice for the Postmedia NetworkThis website uses cookies to personalize your content (including ads), and allows us to analyze our traffic. Read more about cookies here. 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