The pothole

Remember the mortgage cliff we were all going to fall off?

It made for a good tale last year as we brought you news of existing mortgages  amortized for 70, or even 90, years. When the CB rate swelled to 5%, the bank prime was 7.2% and home loans topped 6% it looked like millions of people with cheapo loans taken during Covid would be pooched upon renewal. Distress and listings would surge, Prices drop. Houseless young couples would huzzah and rejoice at the despair and pain of others. All good.

Well, things changed.

The Bank of Canada has chopped multiple times. Recent drops were jumbo half-pointers. The central rate is down to 3.25% on its way to 2.5%. Variable and fixed-rate mortgages are both near the 4.5% mark. VRMs will be 3.75% by the summer – maybe less if Tariff Man moves to wreck our economy. So the difference between the average rate of the 70% of all mortgages coming up for renewal in the next twenty months (2.89%) is not that far off what those folks will be financing at.

The cliff has turned into a pothole. And it’s highly unlikely there’s any massive wave of listings coming from people facing personal ruin. Sorry, GenZs. Tough noogies.

Just to remind us all, the mortgage cliff crisis resulted from the really, really, really bad policy of four of our Big Five banks to lend at variable rates but with fixed payments. So, when interest rates jumped the effective rate on existing VRMs also popped, but homeowners were protected from increases in their monthlies. That meant most, all, or even more-than-all, of their payments went for interest with no principal repaid. Thus it would take far longer to pay down the loan than at the original rate – so the effective amortization were bananas.

When the loans came up for renewal, that am period would reset (by law) to 25 years, with the rate changing to the current one. Meanwhile many loans lacked payments sufficient to cover the interest, so the debt grew even bigger (called ‘negative amortization’).

Anyway, a big crisis looked possible. In response, Ottawa rushed a Mortgage Charter into existence, codifying the banks’ longer-amortization process and telling them to be gentle to renewers. To waive fees. To be more flexible. To hold off on foreclosures, defaults, shaming or harassing families into selling their homes. It almost appeared as if the feds wanted high interest rates – which the CB engineered to cool off the economy and kill inflation – to have no impact at all. Weird.

Largely, they succeeded. Real estate prices survived ten rates hikes and now appear headed for more gains as the cost of money steadily falls.

So, no cliff. It’s over.

Thanks to the data nerds at WOWA, we can see how the big banks have weathered this storm. These guys hold $1.6 trillion in residential mortgages. A year ago 8.5% of those loans were extended past 35 years and 7% were in negative amortization. Now it’s just 2% in both categories, with 65% of all mortgages having an am of less than 25 years. With each rate cut (three more are expected in 2025, maybe more) things look better and better for the bankers.

Click to enlarge. Source: WOWA.ca

But wait. There’s risk on the horizon. Three weeks from now we could be tariffed. We could be heading into a recession. The Spring housing market could be threatened. We could be in the throes of a pivotal election campaign. The dollar could be sinking again.

This is likely a reason one major bank – the blue one – has decided it will buck the regulator’s recent decision to suspend the stress test for renewers and switchers. As trade site Canadian Mortgage Trends first learned, BMO reversed course and has reinstated the test – which frces borrowers with non-CMHC insured loans to prove they can make payments at the higher of 5.25% or 2% above the rate the bank is offering.

“Effective immediately, the change communicated in November will be cancelled, and files will continue to be reviewed using OSFI’s stress test,” says a bank document obtained by CMT.

The bank stated it will continue applying OSFI’s stress test, despite it no longer being mandatory, while it “explores alternative stress test approaches” for uninsured switches at renewal. When reached for comment, a BMO spokesperson told Canadian Mortgage Trends the following: “Our underwriting practices are competitive and consistent with regulatory guidelines.”

Of course all the lenders have a form of stress test that’s applied to renewers as well as newbies. Everyone must clear debt servicing ratios known as GDS and TDS. (As CMHC spells out: “GDS is the percentage of your monthly household income that covers your housing costs. It must not exceed 39%. TDS is the percentage of your monthly household income that covers your housing costs and any other debts. It must not exceed 44%.)

So home loan money is cheaper than it was. The crisis we all thought would crack prices is fading. Mortgage rates will almost certainly be lower in 2025. But the economy will almost certainly be weaker, unless Tariff Man has too many cheeseburgers or decides to terrorize Greenland and Panama instead of us.

Perhaps he’d be interested in buying Drake.

About the picture: “My son’s girlfriend is dog sitting Zar in Victoria,” writes LeeAnn. “Zar (canine corso-mastiff) is sending vibes that Canadians should stay untroubled and rock solid in investments this coming year, despite the scorching heat beside us. Merry Christmas & Happy New Year!”

To be in touch or send a picture of your beast, email to ‘[email protected]’.

Source: https://www.greaterfool.ca/2024/12/26/the-pothole/