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The purpose of raising mortgage interest rates is to reduce spending by blocking investment in new spending. Why then are interest rates being raised on the renewal of existing mortgages? Since the loans are already taken out, raising interest rates on these loans does not block any new investment. The logic of this escapes me.
This rise in mortgage rates has been influenced by the monetary austerity of central banks introduced in response to the surge in inflationary fever. The latter, by playing their card of increasing their key rate, are waging their fight against inflation in order to tighten credit conditions and lower demand.
What economic theory often calls this inflation-unemployment trade-off was all the more muscular as the central banks had to deal with a supply shock situation, then with the resilience of the labor market.
In Canada, this fight to combat inflation has primarily targeted household consumption spending and anchoring inflation expectations around the central bank’s target.
The payment shock faced by variable rate mortgage borrowers and awaiting those who will have to renew their mortgage is therefore both part of the objective and part of the consequences, namely that it has the effect of inducing a fall in consumer spending and a reduction in aggregate demand.
“Payment shock”
In its financial risk assessment published in February, the Office of the Superintendent of Financial Institutions, OSFI, noted that of the total mortgage loan portfolio outstanding in February 2024, 76% would be subject to renewal by the end of 2026.
“Homeowners in Canada renewing their mortgages during this period could experience a payment shock, which will be more severe for those who took out their mortgages when interest rates were lower, between 2020 and 2022. Higher-leveraged households with variable-rate mortgages with fixed payments are likely to feel this shock more acutely.” This latter group accounts for about 15% of outstanding residential mortgages.
Your question raises an interesting point, namely that of renewal, and therefore the choice of loan term. In May, Vice-President, Chief Economist and Strategist Jimmy Jean and Macro Strategist Tiago Figueiredo of the Desjardins Group highlighted the weakness and limitations of a mortgage product offering on the Canadian market, an offering heavily concentrated on fixed-rate loans of up to five years and on variable-rate loans of five years.
This mortgage structure focused on revolving short-term loans “limits the possibilities for protection against rising interest rates,” they say. “This has probably exacerbated the payment shock. Our analysis shows that if the option of fixing the term of a mortgage to 10 years had been more present and attractive, this shock would have been more manageable for households who had chosen it,” they concluded.
For more information, you can read this Economic Viewpoint.
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