A significant portion of Canadian homeowners may be facing a "payment shock" as over 60% of mortgages in the country are set to come up for renewal within the next three years, according to a report by Royal Bank of Canada (RBC). The report highlights the potential financial strain on homeowners if interest rates do not decrease significantly in the coming years.
By 2026, approximately CAD 400 billion ($290 billion) worth of mortgages will be up for renewal, including a large proportion of negatively amortizing loans. This could lead to an average increase in monthly payments of up to 48%, as stated by RBC Capital Markets analyst Darko Mihelic in the report published on Monday.
Mihelic warns that Canadian banks may be at risk of credit losses if interest rates do not decline significantly and the anticipated payment shock occurs. He predicts lower, yet still substantial, payment shocks of 32% for next year and 33% in 2025, as mortgage renewals continue.
The report suggests that if the Bank of Canada's overnight rate, currently at 5%, were to drop by 100 basis points, the payment shock for 2024 and 2025 renewals would decrease to around 22% or 23%. However, the biggest challenges are likely to arise in 2026 when a significant proportion of variable-rate mortgages with fixed monthly payments are set to renew. These borrowers have been making the same monthly payments despite interest rate increases. As a result, they are now only paying the interest each month, thereby extending the time required to pay off the loan. When these mortgages come up for renewal, homeowners will face much higher monthly payments.
The report states that if interest rates do not decline, variable-rate mortgage holders could experience a payment shock as high as 84% by 2026. To mitigate this shock and reduce it to a more manageable 20% for the variable-rate cohort, the Bank of Canada overnight rate would need to decrease to 0.25% by July 2026. However, Mihelic acknowledges that this may be an unrealistic expectation at the moment.
The implications of this payment shock extend beyond individual borrowers to Canada's large banks, particularly in the retail banking sector. RBC Capital Markets maintains a "tepid" forecast for revenue growth of around 4% in 2024 and 3% in 2025 for retail banking in the country. The report highlights that the payment shock could impact loan/revenue growth, lead to an increase in mortgage delinquencies (albeit modestly), and potentially result in losses on other forms of credit.
Despite the potential challenges, Canadian banks are actively working with customers to alleviate the payment shock. Initiatives include encouraging borrowers to increase their monthly payments, make lump-sum payments, extend the loan term, or switch from variable-rate to fixed-rate mortgages.
While the situation poses concerns for both borrowers and lenders, proactive measures by banks may help mitigate the impact of the payment shock. Nonetheless, it remains crucial for homeowners to be prepared and consider their options before mortgage renewals, especially with the potential for significant increases in monthly payments looming on the horizon.