High mortgage rates are taking a bite out of borrowers’ budgets, and the Bank of Canada says they will continue to “feel the strain” for several more quarters to come.
In its latest Monetary Policy Report (MPR), the Bank of Canada looked at the impact of its restrictive monetary policy on mortgages and other debt-servicing costs.
It acknowledged that “the share of income spent on interest payments will continue to rise as homeowners renew their mortgages.”
Since early 2022, the effective interest rate on variable-rate mortgages has jumped by 4.5 percentage points, while fixed rates are up by about half of a percentage point. As of early 2023, the effective interest rate on all outstanding mortgages had risen by 1.75 percentage points, the BoC noted.
The Bank’s modelling forecasts that the interest portion of household mortgage payments will plateau at roughly 5.5% of disposable income by Q3 of this year, the highest level since the late 1990s.
At the same time, the portion of aggregate household income available for discretionary spending is down about two percentage points compared to before the Bank of Canada started hiking rates in early 2022.
“Borrowers may be able to mitigate some of these increased costs; however, their budgets will continue to feel the strain of these costs over the coming quarters,” the Bank said.
Changes in mortgage borrower behaviour
The drastic change in rates has had a significant impact on mortgage terms now being favoured by new borrowers, with most now opting for 1- and 2-year terms.
“Recently, as short-term interest rates have increased, new borrowers have shifted away from variable- and 5-year fixed-rate mortgages toward fixed-rate mortgages with terms between one and four years,” the MPR reads. “This suggests that many borrowers are assuming that mortgage rates will be lower in a few years.”
The Bank noted that financially constrained households may scale back on voluntary mortgage prepayments, with others opting to extend their amortization at renewal time.