Variable-rate mortgage borrowers, who have already seen their interest costs rise by more than 70% over the past year, were hit with yet another hike last week as prime rate reached a 22-year high of 7.20%.
Prime rate, which is used to price variable-rate mortgages and personal and home equity lines of credit (HELOCs), generally takes its cue from movements of the Bank of Canada‘s overnight target rate, which the Bank increased by 25 basis points on Wednesday.
Each quarter-point (0.25%) increase translates into roughly $13 per month for every $100,000 worth of mortgage debt for variable-rate mortgage holders, who currently make up about a third of the mortgage market.
A 70% rise in interest costs in one year
Since the Bank of Canada started hiking rates last March, variable-rate borrowers have seen their monthly interest cost skyrocket by approximately 70%.
“If you’re a variable-rate holder and your mortgage was at prime – 1% last year, you were paying $397.39 [per $100,000 of mortgage],” Dan Pultr, Senior Vice President, Strategic Initiatives at TMG The Mortgage Group, told CMT. “Now, you’re paying $651.74 on a 25-year mortgage, a difference of $254.35 (64% increase), and on a 30-year amortization your difference is $264.86, a 77% increase.”
Given an average mortgage size of roughly $312,000, according to figures from Equifax, that translates to roughly $820 more in interest each month for the average borrower.
Despite the sharp rise in borrowing costs as a result of 10 Bank of Canada interest rate increases, Pultr says variable-rate borrowers have so far been “extremely resilient.”
“What we’ve observed to date is that individuals have found creative ways to manage the increases,” he said. “The big question on everyone’s mind is, when/where is the breaking point?”
For example, Pultr says some borrowers have locked into a fixed rate early, while some have refinanced to extend their amortization and decrease their overall payment, while others who may have used funds to invest in the stock market or other investment vehicles have deleveraged by reducing their overall mortgage and/or debt load.
“Essentially they’ve done whatever it takes to create some level of predictability and management of their monthly cash flows,” he said. “What we have not seen to date is property owners selling their properties because they can’t manage the payments.”
Trigger rates and extended amortizations
The increases have led to higher monthly payments for those with adjustable-rate mortgages. The Bank of Canada estimates these borrowers have seen their payments surge more than 50% as of May—prior to the last two rate hikes.
But those with static-payment variable-rate mortgages are facing another kind of problem. Fixed-payment variable rates, which are offered by banks such as TD, BMO and CIBC, mean the borrower’s monthly payment remains the same, while the portion going towards interest costs rises and the amount going towards principal reduction decreases.
This has resulted in the average amortization period being extended, in many cases to beyond 35 years, which has caught the attention of regulators.
As of May, prior to the last two Bank of Canada rate hikes, a report from Desjardins estimated that more than three quarters of these borrowers had already reached their trigger point, meaning all of their monthly payments were going towards interest costs.
The payment shock for these borrowers will come as their mortgages come up for renewal, when their banks will adjust their monthly payments to get them back on their originally contracted amortization schedule.
Could prime rate reach 7.45%?
What could start to really wreak havoc on current variable-rate mortgage holders are any further hikes beyond this point.
While the Bank of Canada has signalled that any future moves will be heavily dependent on economic data that comes out in the coming weeks, some believe an additional quarter-point rate hike in September remains possible.
“The continued hawkish tone within [the Bank’s] statement and MPR also suggests that another move could well be seen in September, although we suspect that this will ultimately prove to be an overshoot,” CIBC economist Andrew Grantham wrote last week.
For the Bank of Canada to feel compelled to deliver yet another quarter-point hike at its September meeting, Grantham says the economy will have to under-perform compared to the Bank’s latest forecasts and inflation will have to “make quicker progress back to target” than the Bank currently projects.
“That under-performance may not come soon enough to prevent another 25-bp hike at the September meeting, which, given the tone [this week], now seems likely,” he added.
Markets remain in agreement with that assessment. As of Monday, bond markets were pricing in at least 75% odds of another 25-bps hike in September, although those odds can change very quickly as new economic data becomes available.
An additional rate hike would bring the overnight target rate to 5.25%, implying a prime rate of 7.45%. The last time Canadian borrowers saw prime rate that high was in 2000.