Most Canadian mortgage borrowers choose higher interest rate risk exposure

Canadian mortgage borrowers still in the market apparently aren’t worried about higher interest rates. Bank of Canada (BoC) show that the annual growth of new mortgage loans was negative in December. The majority of the remaining activity was issued with floating interest rates. It may not be obvious, but variable mortgage costs are essentially a bearish bet on the economy. The only way these loans won’t go up is if the economy is too weak to raise rates, or if it plunges into a recession. This is a bold call, contradicting the forecasts of experts.

Most Canadian mortgage borrowers want variable interest rates

New mortgages are down, but most of the remaining debt has variable interest rates. Outstanding mortgage debt reached $38.8 billion in December, down 18.7% from a year earlier. Of this debt, lenders issued 54.5% with variable interest rates – a record. People are either blinded by lower upfront costs or see weak economic prospects. The only reason not to raise rates and tackle rising inflation is that the economy is too weak to handle it. This take would be a bet against the consensus, and even against the BoC.

Share of Canadian Variable Rate Mortgage Debt

The share of volumes of Canadian mortgage dollars issued with a variable interest rate.

Source: Bank of Canada; Live better.

Most uninsured mortgage debt had variable interest charges

Uninsured mortgage debt represents the lion’s share of the total mortgage market. In December, lenders issued $32.6 billion worth of uninsured mortgages, down 12.2% from a year earlier. The majority (58.1%) were issued with variable interest rate terms, just below the August/September 2021 peak. Uninsured loans require more equity than insured loans and aggregate loans more important. Paying a few extra basis points could now be seen as insurance against higher rates.

Share of Canadian Variable Rate Mortgage Debt by Segment

The share of volumes of Canadian mortgage dollars issued with a variable interest rate.

Source: Bank of Canada; Live better.

Canada’s insured mortgage borrowers have pulled out of the market

Insured mortgages, where buyers pay less than 20%, remain mostly fixed rate debt. In December, lenders issued only $6.2 billion in insured mortgages, down 41.0% from a year earlier. Lenders have granted 35.7% of mortgage debt with variable terms, also just below the August/September 2021 record. There is much less incentive to adopt variable rates with insured rates, because the costs fixed-term are already at their lowest. Saving a few minor points doesn’t make sense if you see rising rates.

Variable rate mortgages offer a lower initial rate, but expose the borrower to rate increases. The question of whether borrowers can afford the rate hike should be almost non-existent. In Canada, borrowers from the vast majority of lenders are “stress tested” to pay much higher rates. Interest rates can increase by up to 2 points without affecting repayment capacity.

The concern over the increase in variable rate debt is largely due to savings. Many people think they save a lot by going with variable rates, but that may not be the case. If the economy is healthy and rates rise to fight inflation, any savings can quickly disappear.


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