March 10, 2023
Canadians are caught up in the fiercest interest rate shock in decades. Despite punishing payment increases, the overwhelming majority of mortgage borrowers are hanging tough, at least so far.
Take borrowers at First National Financial LP. It’s one of the country’s biggest non-bank lenders with $131-billion of mortgages on its books.
Of its 300,000 residential mortgages, fewer than 200 are 90 days or more behind on their payments. That’s less than 0.07 per cent, a record low and incredibly minimal given current financial stresses. (Industrywide, according to Canadian Bankers Association data, the arrears rate was 0.23 per cent five years ago.)
Mind you, 90-day arrears are a somewhat lagging indicator. Thirty-day arrears are a better gauge of recent borrower performance, and in that case, they’re actually falling relative to First National’s third quarter last year.
So what gives? How are today’s highly-leveraged mortgage borrowers tolerating 325- to 425-basis-point hikes in mortgage rates? (A basis point is 1/100th of a percentage point).
Here are eight things that can explain it.
“The overwhelming majority of our portfolio, and any lender’s portfolio, still has a great deal of positive equity,” said Jason Ellis, First National president and chief executive officer, in an interview over Zoom. A great deal of positive equity means typical borrowers owe a lot less than their homes are worth. That makes it more likely that troubled borrowers can sell the property and pay out their mortgage, or get a second mortgage with a non-prime lender. (Side note: Home sales and non-prime credit availability are less than usual. Having ample equity thus makes selling or refinancing to pay off debt “easier” for many, but not necessarily “easy.”)
Canada’s regulators keep a close eye on lender loan performance so borrowers are properly underwritten from the get-go. Lenders generally limit borrower debt loads to 44 per cent of gross income. They chose that number knowing that people would exceed it if rates rose or incomes dropped. More over, regulators force people to prove they can afford rates at least 200 basis points higher than their actual rate. Borrowers renewing a five-year fixed mortgage are now renewing “at or below what their qualifying rates would have been five years ago,” Mr. Ellis said.
Rates have soared on a percentage basis, but payments haven’t risen anywhere near as much. If you had an adjustable-rate payment based on prime – 1 per cent, a common rate one year ago – you’ve gone to 5.70 per cent from 1.45 per cent. Your rate is now 293 per cent higher, but the payment is only 56 per cent higher. “Fifty-six per cent can be a terrifying number for sure,” Mr. Ellis agrees. However, this $223 monthly payment increase per $100,000 of mortgage is made more manageable by the points below.
“Unemployment near generational lows is the most important part of this conversation,” said Mr. Ellis. Mortgage arrears usually only spike after a surge in unemployment. That may happen, but it hasn’t yet. More over, incomes have grown for most mortgagors, helping them service their debts. A 5-per-cent wage boost on a $100,000 income helps one afford almost $300 more on a mortgage payment.
People in a bind will cut back on spending, which they always do before they begin missing mortgage payments. Spending on discretionary goods is already starting to roll over and services spending will follow.
In 2020, many took advantage of government stimulus and essentially no-questions-asked six-month mortgage deferrals. Some mortgagors are still drawing down on the record savings they accumulated.
Mom and dad
“We’ve seen an increase in gifted down payments as a source and percentage of down payment funds,” Mr. Ellis said. “Parents are passing along some of their housing wealth. It’s possible that for first-time buyers seeing payment pressure, there may be a greater propensity for parents to help with the monthly payments.”
The last thing a lender wants on its book is a default. Compared with decades gone by, most lenders are now more willing to work with borrowers who ask for help before missing payments. Solutions include temporary payment holidays where missed payments are added back to the mortgage balance, and amortization extensions to lower payments. Some banks are allowing borrowers who make hardship requests to extend their amortizations up to 30 to 40 years, with no fees or penalties. “It’s not hard to get it done,” said broker Ron Butler, of Butler Mortgage Inc. “Although it’s never advertised.”
Borrowers that some might deem riskier also seem to be holding their own. “About a quarter of our overall portfolio are adjustable-rate mortgages and they’re performing every bit as well as fixed-rate borrowers,” said Mr. Ellis.
And non-prime loans? “We have not seen a spike in arrears, or challenges at renewal. So far, our non-prime borrowers have not shown less resilience than prime borrowers,” he adds.
Now, First National may not be representative of the entire mortgage market, but they do represent a huge sample size of borrowers. And given they fund a higher share of default-insured loans, they skew toward younger borrowers, including first-time buyers, many of whom have fewer assets or less-established employment. Hence, it’s reasonable to say the average prime lender isn’t facing significantly worse default risk.
Can all this change? Of course. If the Bank of Canada had to boost rates another 100 basis points, for example, all bets are off.
To be clear, everything is not rosy. A meaningful minority of mortgagors are facing severe budgetary pressure. Many are exhausting the last of their financial resources. As unemployment mounts, we will see defaults climb.
But that is natural and expected in every rate-hike cycle.
So far, the overwhelming majority of mortgagors are holding their own. Lenders are sufficiently capitalized and mortgage defaults are unlikely to counteract immigration, rising incomes and supply constraints to hammer home prices much more.
Now we just need inflation to drop as forecast, to ensure it stays that way.
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