Mortgage expert dives into the potential implications of Bank of Canada's aggressive policy tightening
As the Bank of Canada embarks on what could prove to be a whatever-it-takes campaign to tamp down surging prices, Canadians homeowners who took part in the pandemic debt binge of the past two years could be facing a reckoning.
“According to the Bank of Canada, total real estate-secured lending has gone from nearly $1.48 trillion in Q1 of 2020, to roughly $1.78 trillion in Q1 of 2022,” says Sung Lee, a licensed mortgage agent and mortgage expert with RATESDOTCA. “So that's an increase of $300 billion or roughly 20%.”
Citing data from the BoC, Lee says re-advanceable mortgage borrowing, which combines mortgages and home equity line of credit products, increased 34% during the same time. It reached $737 billion in Q1 2022, which represents nearly 42% of all residential secured lending.
“Over the past couple of years, we’ve had a perfect storm of super-low interest rates and soaring home values,” he says. “That meant homeowners had much more equity they could tap into with minimal interest cost. So many homeowners took this opportunity to build up wealth through home renovations to increase their property values, while others took this equity out to purchase investment properties.”
Even as real estate-secured financing rose, StatsCan data from the onset of the pandemic in February 2020 to January 2021 shows non-mortgage debt – which includes unsecured lending like credit card debt, and auto loans – fell by $20.6 billion or 18.3%. Under lockdowns and unable to spend their disposable income on experiences outside their homes, Canadians were able to make larger payments towards their debt. Many also refinanced or leveraged home equity line of credits (HELOCs) to pay off higher interest-rate debt.
But as the Bank of Canada starts to hike its policy rate from historic lows, Canadians with variable mortgages are already feeling pinched. In a speech to the Gatineau Chamber of Commerce a day after the central bank unveiled its latest 50-basis point hike, Deputy Governor Paul Beaudry indicated that it’s open to hiking rates up to at least the top end of its 2%-3% neutral range by the end of the year.
From a cash flow perspective, another 150-basis point increase would mean having to pay an extra $78 monthly per $100,000 of mortgage for an adjustable-rate mortgage holder, according to Lee’s estimates. Someone with a $500,000 mortgage, meanwhile, would be shouldering an extra $390 a month. As for HELOCs, that increase would mean an extra $1,500 per year of interest per $100,000, or an extra $125 per month.
“We've noticed that many financial institutions would send out communications on the same day or the day after a rate decision that they are adjusting their prime rate,” Lee says. “In terms of when it reflects on the client's statement or bank account, it could show on their next bi-weekly payment, or the following month, so it's a fairly quick impact.”
Financial institutions do financial stress tests when they receive applications for a mortgage, which should provide some capacity for mortgage-holders to handle higher payments. But as Lee notes, those stress tests don’t consider day-to-day expenses such as childcare, gas, streaming service subscriptions, and cellphone bills. With higher interest rates on the horizon, he says some Canadians may want to evaluate their budgets and separate their need-to-haves from their nice-to-haves.
“The other thing to understand is that Bank of Canada is increasing rates to tame runaway inflation,” Lee says. “As the impact of these rates take hold, we should hopefully begin to see inflation slowed down, eventually getting back to reasonable levels.”
While some HELOC holders may be feeling a measure of borrower’s regret, Lee believes HELOCs are a useful product, as they allow homeowners to leverage their most valuable asset to get the lowest rate they’ll find on revolving debt. But the critical point to note is to use them wisely: he suggests using them for emergency funds, home renovations, and to pay off high-interest rate debt as ideal uses, while less ideal applications would be to pay for vacations or spending on regular day-to-day expenses.
“I would caution individuals about banking on their home equity as their sole source of wealth accumulation,” Lee says. “Real estate is an important asset class, but it's always necessary to have a diversified portfolio and not just put all your eggs into a single home basket.”