The 10-fold increase in interest rates since March of 2022 has affected Canadians in almost every area of their financial lives, as individuals and families struggle to cope with the every-increasing bite that interest costs take out of their budgets.
Probably no group has been more affected by increased interest costs than homeowners who have a mortgage on their family home and must find room in their budget to make ever-increasing payments on that mortgage.
There are basically two types of mortgages held by Canadians. The first is a fixed rate mortgage in which, as the name implies, the rate of interest payable is set for a fixed term of, usually, one to five years. The required monthly payment is also set for the entire term and will not change, meaning that such homeowners are not affected by any change in interest rates during the current term of their mortgage. They will, however, have to renew that mortgage at the end of the current term, at whatever interest rates are then in effect.
The other major type of mortgage financing is a variable rate mortgage, in which the interest rate payable on the mortgage amount goes up with every interest rate increase announced by the Bank of Canada and passed on to consumers by Canadian financial institutions. Homeowners who have a variable rate mortgage can have one of two types of repayment arrangements. The Financial Consumer Agency of Canada explains the two types of payment arrangements in this way:
Adjustable payments with a variable interest rate
With adjustable payments, the amount of the required mortgage payment changes if the interest rate changes. A set amount of each payment applies to the principal amount of the mortgage (the loan amount), while the interest rate portion changes as interest rates change.
Fixed payments with a variable interest rate
With fixed payments, although the rate of interest payable changes as interest rates change, the amount of the required mortgage payment stays the same.
However, when interest rates change, the allocation of that fixed payment between principal and interest also changes. If the interest rate goes up, more of the payment goes towards the interest, and less to the principal. If the interest rate goes down, more of the payment goes towards the principal.
Where interest rates increase substantially, as they have done over the past year and half, homeowners who have a variable interest rate mortgage with fixed payments are at risk of reaching the point at which their payments no longer cover even the required interest payment. In other words, although they are making payments on time and in the required set amount, their overall mortgage principal is increasing every month, as interest amounts which have not been paid are added to that mortgage principal – a situation known as negative amortization.
Finally, while holders of fixed rate mortgages (in which the interest rate does not change during the term of the mortgage) are currently sheltered from the impact of increased interest rates, they are unlikely to remain in that position much longer. According to the Bank of Canada, almost all borrowers will see an increase in mortgage interest costs over the next three years, and the Bank’s data suggests that holders of fixed rate mortgages will see their payments increase by between 20% and 25% at their next renewal.
Looking at the current pressures being experienced by holders of variable rate mortgages, as well as the impact that mortgage renewals will have in the near future on holders of fixed rate mortgages, the Financial Consumer Agency of Canada (FCAC – a federal agency whose responsibilities include protecting the rights and interests of consumers of financial products and services and supervising federally regulated financial entities, such as banks) determined that new measures were needed to address both current and upcoming risks. Those measures outline the expectations of the FCAC with respect to mortgage lending practices by federally regulated financial institutions (which would include all major lenders – a full listing can be found at https://www.osfi-bsif.gc.ca/Eng/wt-ow/Pages/wwr-er.aspx?sAll= 1), in situations in which homeowners can be characterized as “consumers at risk” with respect to their mortgage payment obligations. For purposes of the new guidelines, “consumers at risk” means those who have variable rate mortgages and whose payments (or the portion of their payments allocated to interest charges) have increased materially, or who may be facing negative amortization, or those who have fixed rate mortgages which will be up for renewal in the near future and who are also facing a material increase in payments.
Where a homeowner is facing a material increase in mortgage payments, or negative amortization, the FCAC’s expectation is that the financial institution holding that mortgage will provide temporary mortgage relief in the following specific ways:
- waiving prepayment penalties where such a homeowner makes a lump sum payment to avoid negative amortization, or sells their principal residence;
- waiving, for a limited period, internal fees or costs which would otherwise be charged when mortgage relief measures are activated: and
- ensuring, for a limited time, that where mortgage relief measures result in negative amortization no interest is charged on interest which has been added to mortgage principal.
Where homeowners fall short or fall behind in meeting their mortgage payment obligations, the longer-term financial repercussions – in the form of higher interest rates charged on future borrowings, or a negative impact on the homeowner’s credit rating, or both – can be significant. The new guidelines address both of those risks, as follows:
- at the time of mortgage renewal, the homeowner should not be offered a less advantageous interest rate based on the homeowner’s inability to adjust his or her mortgage agreement, or to qualify with other lenders; and
- where mortgage relief measures are provided, and the new arrangements include the ability to make a late payment or be delinquent on the mortgage generally, those late payments or that delinquency should not be reflected on the homeowner’s credit report.
Where homeowners run into difficulty with paying their mortgage, one of the relief measures which can be provided is to extend the time period over which the mortgage must be repaid – the amortization period. While an extension of the amortization period will mean lower payments, those lower payments also mean that more interest will be paid over the life of the mortgage and, of course, that it will take longer before the homeowner is mortgage-free.
Extension of the amortization period of a mortgage is one of the relief measures set out in the new guidelines. However, those guidelines also impose specific steps to be taken by the financial institution which provides the extended amortization. Any such extension must be for the shortest period possible, and the financial institution is expected to work with the homeowner to develop a plan which:
- ensures that the total amortization period is reasonable;
- includes information about options to restore the amortization to its original period; and
- includes an assessment and communication of the potential long-term, negative financial implications of the change in the amortization period.
Finally, where any mortgage relief measures are provided, the onus is on the financial institution to provide specific information to the homeowner before implementing any such measures. That information must include:
- the outstanding amount owing on the original credit agreement for the mortgage before the mortgage relief measures take effect;
- the impact of the mortgage relief measures on the total cost of servicing the mortgage, in dollar figures, as well as the remaining amortization (or repayment) period after the relief measures take effect;
- the new payment amount, due date, and frequency;
- the new interest rate and type (that is, fixed or variable); and
- the date on which the changes will take effect.
The new guidelines expect financial institutions to proactively monitor their clients to permit early identification of signs of financial stress, and to proactively contact consumers at risk regarding possible mortgage relief measures. However, consumers who are at risk of falling into default on their mortgage obligations are well-advised to also be proactive in contacting their financial institution where mortgage relief is needed – armed with knowledge of the kinds of relief which can be provided, and on what terms.
Detailed information on the new mortgage relief guidelines is available on the federal government website at https://www.canada.ca/en/financial-consumer-agency/services/industry/commissioner-guidance/mortgage-loans-exceptional-circumstances.html.