The floaters

In traipsing about the Dark Side yesterday, this blog mentioned how the big boys are dealing with mortgage rate stress. The bankers have been busy running up amortizations.

Whazzat mean?

So, a third (roughly) of all the outstanding residential mortgages were taken out by people who wanted variable rates, usually because they were cheaper than locking in for five years. Over decades, this has been a winning strategy. But not now.

As the Bank of Canada hiked its benchmark rate eight times, a VRM went from a low of 1.5% to the current 6.5%. Big ouch. Most of these borrowers have floating rates, but fixed payments. As the cost of their borrowing increased, more and more of the monthly went to interest until a ‘trigger point’ was reached – when 100% of the payment was thus. No debt being paid. And that’s not kosher with an amortized loan.

In many instances, interest charges have  surpassed the fixed monthly, so the actual debt is expanding, not contracting. Every day home equity decreases – something that’s been exacerbated as the real estate market in general (and especially in Bunnypatch) faded away.

Lenders don’t want foreclosures, jingle mail, powers of sale or to be in the business of owning houses. So, one solution to this mess has been to extend amortizations for these afflicted clients. By adding five or ten years to the period of time over which payments (debt plus interest) are calculated, the interest portion of the monthly is reduced and the loans come onside.

It’s incredible, but with the bank we mentioned yesterday – the penguin one – variable-rate clients with ams over 35 years now constitute 27% of the book. A year ago it was 0%.

What is the outcome?

The homeowners get to keep the real estate and their monthly payments do not increase. However the size of the debt can augment, and over time interest charges escalate. When it comes to renew the loan, they’ll see that years of payments may not have reduced their debt, while the home itself is worth less. Net worth shrinks. It would have made more sense, in other words, to rent – especially when closing and selling costs are taken into consideration. In fact, in a market where valuations have dropped the homeowner may be unable to sell without having to cut a big cheque to the lender on closing day. Hello Milton. Hiya Brampton.

Here’s a small example of what stretching amortization can do. On a half-million-dollar loan at 5.25%, going from 25 to 30 years reduces the monthly by about two hundred bucks. But over the life of the loan, interest charges rise by almost a hundred thousand.

The fervent hope of the current triggered VRM people is that interest rates start heading back down a little in 2024, allowing them to get back onto that 25-year schedule. But is that likely, for some of the reasons outlined on this pathetic blog 24 hours ago? Maybe not. Perhaps we have hit a new normal for mortgages with a bank prime rate stuck north of 6.5%.

Here’s the big worry. ARMs equal, as mentioned, about a third of all Canadian mortgages. In the States (where they learned this lesson 15 years ago) only 5% of home loans are at floating rates. This leaves us massively more exposed to the rate-tightening of central banks. Meanwhile, Canadians have been far house hornier than Americans, with real estate at nosebleed price-to-income ratios. It’s astonishing that 70% of all VRM borrowers here are now repaying no principal.

A big chunk of those folks are investors. They took a VRM to finance a pre-con or rental condo, now in negative cash flow with no prospect of that changing. Many have decided to bail. Many more will likely follow.

So the Bank of Canada will keep rates where they are on Wednesday. The US Fed will hike in two weeks. Our guys may reverse course and add a quarter point in mid-April. Or maybe not. Everything is data-dependent these days, with policy vacillating from one CPI or jobs report to the next. What’s increasingly clear is that no pivot is likely for a year, a least. No reversal. No drop in the cost of money, the bank prime or variable-rate mortgage costs.

Too many buyers rolled the dice, went cheap, and lost. Along the way their avarice and bad choices helped escalate real estate and bring us to this moment.

Should we have sympathy?

About the picture: “Daily long time reader, and much appreciate the blog,” writes Thom. “We are visiting our daughter in Brisbane, Australia for the winter. Here is her new guy “Shrimp”. He is a lively lovable one.”