According to recent research conducted by the Bank of Canada, moderate income gains could help alleviate severe financial stress for most Canadian mortgage holders when they renew their home loans at significantly higher interest rates.
Impact on Debt Serviceability
The report, released on Wednesday, highlights that in the absence of income growth, the median borrower may have to allocate up to 4% more of their pretax income towards mortgage payments by the end of 2027. However, the report emphasizes that income growth has the potential to mitigate the impact of higher interest rates on debt serviceability for certain borrowers.
Concerns over Canadian Consumption Slowdown
There are growing concerns regarding a potential prolonged slowdown in Canadian consumption. As of the third quarter, an estimated 700 million Canadian dollars (equivalent to $525 million) worth of mortgages are set to renew in 2024 and 2025 at higher rates. This amounts to approximately 30% of Canada’s gross domestic product.
Mortgage Terms in Canada
Unlike the United States, where mortgages often have longer terms, Canadian lenders typically provide mortgages with shorter terms, generally lasting five years.
Research Simulations
To arrive at these projections, the Bank of Canada researchers conducted simulations based on market expectations for interest rates. They also factored in mortgages taken out before March 2022 when the central bank began raising rates.
These findings give valuable insights into the potential impact of higher interest rates on mortgage holders in Canada. The research highlights the importance of moderate income gains in mitigating financial stress and acknowledges the need for continued monitoring of the country’s housing market.
Rising Mortgage Payments Projected to Increase
According to a recent study, median monthly mortgage payments in Canada are predicted to rise by an alarming 34% by the end of 2027. This increase could have a significant impact on homeowners, specifically those who experience no income growth from the start of their mortgage to the time of renewal. For this group, their mortgage debt-service ratio (monthly payment as a share of pretax income) is expected to rise by four percentage points, reaching 20%.
On the other hand, homeowners whose income grows at a rate of 2.4% per year, which is the average change in wages over a nearly 10-year period ending on September 30th, may face a more modest increase of 1.5 percentage points in their debt-service ratio.
Although income growth helps to mitigate the effects of rising interest rates on debt serviceability, the study acknowledges that the increase in the debt-service ratio would still be historically significant considering the magnitude of these interest-rate hikes.
Presently, annual wage growth in Canada ranges from 4% to 5%. However, data indicates that this pace of income gains is not consistent with achieving a 2% inflation goal set by the Bank of Canada. The central bank’s main interest rate remains at 5%, and officials believe it is premature to consider any rate cuts at this time.