Bank of Canada’s Carolyn Rogers flags first-time homebuyers facing 'trigger rates' as risk

Bank of Canada senior deputy governor Carolyn Rogers acknowledged that rising rates were putting a greater strain on young Canadians — especially if they bought a home during the pandemic.

Rogers flagged rising household debt rates as a growing financial system risk, which escalated during the pandemic as Canadians piled into mortgages when interest rates were at historic lows. The central bank’s aggressive rate hiking cycle, which brought the policy rate from near-zero at the start of the year to 3.75 per cent, is beginning to take its toll on highly indebted young Canadians.

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“We know higher interest rates are difficult for many Canadians — particularly young Canadians — many of whom are recent homebuyers and are therefore carrying higher debt loads,” Rogers said in a Nov. 22 speech before the Ottawa chapter of Young Canadians in Finance.

Rogers pointed to inflation, volatility in commodity and financial markets as well as increased debt levels as risks to financial stability. Debt is a particular concern because borrowers on variable-rate mortgages are now reaching their “trigger rates” — the point where the monthly mortgage payment only covers the interest and is not paying down the principal.

“One group of Canadians who will be finding this adjustment painful are those who recently purchased a home, potentially stretching their budget to do so, and who chose a variable-rate mortgage,” Rogers said. “This is not a large share of households, but it is larger than it would have been based on historical trends. This is because more Canadians opted for a variable-rate mortgage over the last year than have in the past, at a time when housing prices were high.”

The Bank of Canada estimates that variable-rate mortgages account for about one-third of total outstanding mortgage debt, an increase of about 20 per cent since the end of 2019.

About 50 per cent of variable-rate, fixed-payment mortgages — or nearly 13 per cent of all Canadian mortgages — have already hit their trigger rates where monthly mortgage payments may increase. 

Royce Mendes, managing director and head of macro strategy at Desjardins Group, said the Bank of Canada was now beginning to see the effects of its rate-hiking campaign ripple into mortgages.

“We estimate that just about all variable-rate mortgages taken about between May 2020 and July 2022 are now in this position [trigger rate]” Mendes wrote. “The more that monetary policymakers raise rates, the more interest these borrowers will owe. However, as the Bank of Canada’s research suggests, that doesn’t necessarily mean all of those homeowners will need to top up payments. Some lenders will allow for negative amortization.”

Since the global financial crisis in 2008 safeguards have been put in place to buffer the impact of such economic shocks, said Rogers, who also noted that higher capital requirements and liquidity levels for banks should protect the stability of the financial system.

“Here at home, these measures also included a borrower-level mortgage stress test to ensure Canadians could continue to afford their homes when interest rates rose,” Rogers said. “And, importantly, we are not expecting a severe economic downturn with the kind of large job losses typical of past recessions.”

During  a November speech on labour markets, Bank of Canada governor Tiff Macklem made the case that the high level of job vacancies in Canada could provide a buffer to limit layoffs in the next downturn.

However, the heads of the central bank noted that young Canadians particularly are feeling the pressure of high inflation and rising borrowing rates.

“High inflation is something we haven’t seen in Canada in more than three decades, which means many in this room are experiencing it — and the stress that comes with it — for the first time,” Rogers told students at the University of Ottawa.

“It’s undoubtedly frustrating to face the uncertainty of inflation and the impact of higher interest rates at a point in time when you are just getting financially established — building your career, buying a house, starting a family.”