Canadians are caught in the fiercest interest rate shock for decades. Despite punitive payment increases, the overwhelming majority of mortgage borrowers are holding out, at least so far.
Take borrowers at First National Financial LP. It is one of the largest non-bank lenders in the country with $131 billion in mortgages on its books.
Of its 300,000 residential mortgages, less than 200 are 90 days or more behind on their payments. That’s less than 0.07%, an all-time high and incredibly minimal given the current financial strains. (Industry-wide, according to data from the Canadian Bankers Association, the arrears rate was 0.23% five years ago.)
Please note that 90 days past due is a somewhat lagging indicator. Thirty-day arrears are a better indicator of recent borrower performance and, in this case, are actually down from First National’s third quarter last year.
McLister: This week’s lowest fixed and variable mortgage rates in Canada
So what gives? How do today’s heavily indebted mortgage borrowers tolerate mortgage rate hikes of 325 to 425 basis points? (A basis point is 1/100th of a percentage point).
Here are eight things that may explain it.
“The overwhelming majority of our portfolio, and any lender’s portfolio, still has a lot of positive equity,” Jason Ellis, president and CEO of First National, said in a Zoom interview. Much positive equity means that typical borrowers owe much less than their home is worth. This makes it more likely that distressed borrowers can sell the property and pay off their mortgage, or get a second mortgage from an unpreferred lender. (Note: home sales and the availability of non-prime credit are less important than usual. So having enough equity makes selling or refinancing to pay off debt “easier” for many, but not necessarily “easy. “.)
Regulators in Canada closely monitor the performance of lenders’ loans to ensure that borrowers are properly underwritten from the start. Lenders generally limit borrowers’ indebtedness to 44% of gross income. They chose this figure knowing that people would exceed it if rates went up or incomes went down. Additionally, regulators require people to prove they can afford rates at least 200 basis points above their actual rate. Borrowers renewing a five-year fixed mortgage are now renewing “at or below what their qualifying rates would have been five years ago,” Mr. Ellis said.
Impact on payment
Rates went up as a percentage, but payments didn’t go up as much. If you had a variable-rate payment based on the prime rate — 1%, a common rate a year ago — you went from 1.45% to 5.70%. Your rate is now 293% higher, but the payout is only 56% higher. “Fifty-six percent can be a terrifying number for sure,” agrees Mr. Ellis. However, this monthly payment increase of $223 per $100,000 mortgage is made more manageable by the points below.
“Job the near generational troughs are the most important part of this conversation,” Mr. Ellis said. Mortgage arrears typically only spike after a spike in unemployment. It may happen, but it hasn’t yet. In addition, incomes have increased for most mortgagors, which has helped them to pay off their debts. A 5% pay rise on a $100,000 income helps pay nearly $300 more on a mortgage payment.
People in trouble will cut spending, which they always do before they start missing mortgage payments. Spend on discretionary assets is already starting to roll in and service expenses will follow.
In 2020, many took advantage of government stimulus and six-month mortgage deferrals essentially no questions asked. Some mortgagors are still pulling on this record savings they accumulated.
Mom and dad
“We’ve seen an increase in gifted deposits as a source and percentage of deposit funds,” Ellis said. “Parents pass on part of their real estate assets. It’s possible that for first-time buyers who see the pressure of payments, there’s a greater propensity for parents to help with monthly payments.
The last thing a lender wants on their book is a default. Compared to decades past, most lenders are now more willing to work with borrowers who seek help before they miss payments. Solutions include temporary payment holidays where missed payments are added to the mortgage balance, and amortization extensions to lower payments. Some banks allow borrowers who make hardship claims to extend their amortizations up to 30 to 40 years, without fees or penalties. “It’s not hard to do that,” said broker Ron Butler, of Butler Mortgage Inc. “Although it’s never announced.”
Borrowers that some might consider riskier also seem to be holding up. “About a quarter of our overall portfolio is adjustable rate mortgages and they perform just as well as fixed rate borrowers,” Ellis said.
What about non-privileged loans? “We haven’t seen a spike in backlogs or difficulties with renewal. So far, our non-preferred borrowers have shown no less resilience than prime borrowers,” he adds.
Now, First National may not be representative of the entire mortgage market, but they do represent a huge cross section of borrowers. And because they fund a higher share of default-insured loans, they favor younger borrowers, including first-time buyers, many of whom have fewer assets or less established employment. Therefore, it is reasonable to say that the average primary lender does not face significantly worse default risk.
Can all this change? Of course. If the Bank of Canada were to raise rates an additional 100 basis points, for example, all bets are off.
To be clear, all is not rosy. A significant minority of mortgage debtors are facing strong budgetary pressures. Many are exhausting their last financial resources. As unemployment rises, we will see defaults climb.
But this is natural and expected with every rate hike cycle.
So far, the overwhelming majority of mortgagors are defending themselves. Lenders are adequately capitalized and mortgage defaults are unlikely to thwart immigration, rising incomes and supply constraints to drive home prices much further down.
Now we just need inflation to come down as expected, to make sure it stays that way.
Rates are as of March 9 from providers who advertise rates online and lend in at least nine provinces. Insured rates apply to those buying with less than 20% down or those transferring a pre-existing insured mortgage to a new lender. Uninsured rates apply to refinances and purchases over $1 million and may include applicable lender rate premiums. For providers whose rates vary by province, their highest rate is shown.
Robert McLister is an interest rate analyst, mortgage strategist and editor of MortgageLogic.news. You can follow him on Twitter at @RobMcLister.