The hard landing

In 16 days interest rates rise again. By half a point, most econs agree. So, the Bank of Canada rate will have swelled from 0.25% to 4.25% in nine months.

That’s a record. Up 1,600%. Variable-rate mortgages in the 1.5% range last winter are 5.5% to 6% at the big banks now.

But those are the lucky borrowers. More on their situation in a moment.

First, consider the financial lepers in out society – the lowly commission-only workers, contractors, gig employees or the worst (shudder) – the self-employed. These folks have always been given the bum’s rush by lenders, and many have ended up getting house money from the subprime guys or private mortgage lenders. What a disaster has been unfolding there, with rates now in the eight per cent range and loans unrenewed, leaving borrowers scrambling and listing properties in distress.

This is the tip of the real estate iceberg. So much more hurt lies just beneath the surface.

Crusty Toronto mortgage broker Ron Butler, as usual, is in the trenches. “Lenders are just asking for their money back,” he says. “A $70,000 second mortgage, given 30 days to find a way to pay it back or face a power of sale. These are regulated institutions who work with folks with lower FICO scores, or self-employed. Income that the banks won’t work with.”

And here’s one he cites for the record books.

Current Mortgage: $2.37M
Current Rate: 3.29%
Payment: $9,646 Monthly
New Rate: 8%
Payment: $17,248 Monthly

The house, Butler reports, “will be sold.” Or, at least, it will be listed for sale. Since the top end of the market has been falling apart lately, it might take some time to find a buyer greater fool.

Now how about the regular plebs with their paltry $400,000 or $800,000 home loans taken in 2020 or 2021 at less than 2% when everybody on this site was telling you ‘it’s different this time’ and ‘the government will never let rates rise’?

Well, the pain’s on the way. Gird your loins. There’s mortgage crisis on the horizon for many who eschewed the advice of a certain pathetic blog and took a VRM a year or two ago, to allow lower payments or a higher debt load. Bad dogs.

Here’s the rub: as the BoC benchmark jumps, so do VRM rates. However most banks allow fixed monthly payments. That means homeowners don’t really see the epic ascent while more and more of their payments go to interest. At a certain point (called the ‘trigger’) most or all of the monthly is interest. No debt. We’re at that point now for hundreds of thousands of families.

Two major lenders (the green one & the penguins) are allowing a portion of this bloated interest to be glued onto the mortgage principal, so payments remain stable but every month the homeowner has more debt and less equity. Not exactly what anyone expected when they bought a pandemic property.

This is called negative amortization. Kinda like one of those squirrely reverse mortgages, where the oldie gets a wad of cash but the debt load grows bigger daily. The trouble is, federal banking regs have stipulated a mortgage must always be amortized, or routinely paid down. The reason is simple – an unserviced loan could grow larger in size than the equity in the asset being financed. And that is a bank risk.

CHMC says it’s okay with negative amortization, so long as the mortgage is recalculated at least every five years to bring it back into the original repayment schedule. But with rates having exploded higher, that means a huge jump in monthly payments looms on the horizon. For someone who bought with 5% or 10% or even 15% down, it could spell financial chaos.

Says blog dog and K-W lawyer Michael: “Where is OFSI (the bank regulator) going to stand on this – are they going to lay the hammer down on these banks for allowing an increase in mortgage principal and amortization past agreed amount and leave secondary mortgages in an equity risk depletion position? Combine that with declining real estate values! Watch out!”

Meanwhile, here’s another warning sign: 30-year amortizations.

Word is the number of longer amortizations (which allow lower payments but inflate interest costs) are augmenting fast. They’ve doubled in three months. Some banks now have a quarter of their mortgage portfolios in thirty-year terms. Many people seem willing to pay far more interest over the years ahead in order to swallow real estate debt they (in reality) cannot afford.

So, on December the 7th, variable-rate mortgage costs will rise again with the chartered bank prime. That will probably not be the apex. Expect one (maybe two) more tweaks in early 2023. Then with VRMs at north of 6% and five-year fixed loans above that, rates will pause as the CB assesses inflation and economic growth. There will be no pivot in 2023 – no reduction, since the Bank of Canada will have reached a ‘normalized’ level consistent with history. Why would policymakers volte-face, encouraging more debt? Why let inflation back out of the bag?

They won’t. Hard homeowner landing ahead.

About the picture: “I enjoy your blog and appreciate your use of humour to spice up otherwise bland subjects,” writes Jim. “This is our pup Delilah who sadly passed earlier this year. We had tried to keep her off our new chair but she persisted and we eventually gave up. I swear she has a smile on her face in this photo, knowing that she had “won” and secured her own little piece of real estate.”