Ottawa - Canadian homeowners may be in for a shock when it's time to renew their mortgages, as rising interest rates will likely also mean higher monthly payments.
These payment increases are particularly unwelcome as rising prices for gasoline, groceries and other essentials are already eating into household budgets.
Experts believe that extending the amortization period of a mortgage could help control monthly payments, even if interest rates are higher. But beware: such a move comes at a cost as it increases interest costs, which are paid over a longer period of time.
Mike Rocha, director of the mortgage experience at Scotiabank, points out that customers renewing today who may have gotten interest rates under 3% or even 2% in the past are facing rates that could potentially reach over 4%.
"There's definitely going to be a potential payment shock with some customers," he points out.
The amortization period is the period of time during which the loan is repaid. That means that for a mortgage taken out five years ago to buy a house with a 25-year amortization period, there are 20 years of payments left.
By extending this amortization period at mortgage renewal, it is possible to take the remaining balance on the mortgage and pay it off over a new 25-year period, or even longer, depending on the situation. This decision would reduce the monthly payment, but because of the additional time required to pay off the loan, the interest will be paid over a longer period of time.
Borrowers who have made extra payments in the past and are ahead of their original payment schedule should be able to revert to their original amortization schedule, notes Mike Rocha. However, to extend the amortization period beyond the original contracted period, the process is a bit more complicated.
"You have to qualify, you have to check the credit. There may be an appraisal, it depends on the lender. It's a longer process, for sure," he says.
Central bank scenarios
While those with variable-rate mortgages have already seen their rates rise when the Bank of Canada began raising its key interest rate, those with fixed-rate mortgages won't see an increase in the rate they pay until they renew.
According to data compiled by Ratehub.ca, discounted five-year fixed mortgage rates in July 2017 averaged 2.24%. And while some were able to sign up for five-year fixed mortgages at rates below 2.0% last year, offers from major Canadian banks are now above 4.5%.
In its review of the financial system last week, the Bank of Canada noted that rising rates could lead to a tightening of household budgets.
The central bank launched a hypothetical scenario in which five-year variable-rate and fixed-rate mortgages subscribed in 2020 and 2021 were renewed at median rates of 4.4% and 4.5%, respectively, in 2025 and 2026. In its simulation, the Bank of Canada indicates that households that took out a mortgage in 2020-2021 would see a median increase of $420 or 30% in their monthly mortgage payments at renewal.
However, Ottawa-based mortgage broker Kelly Wilson notes that while rates are higher today than they have been in recent years, they are still low in a longer-term context.
"I bought my first home when I was 21 and paid 8.3%, which was my first interest rate," recalls Kelly Wilson, managing partner of the Wilson team.
A less expensive loan than others
Kelly Wilson points out that while extending the amortization period forces you to pay interest for a longer period of time, it can also free up money now to help pay off other, more expensive debts, or save for retirement, which can generate a higher return than the amount paid in interest.
"It's still a cheaper loan than any other loan," she reminds.
Mike Rocha adds that if the amortization period has already been extended, it's always possible to consolidate other higher-interest debt into your mortgage.
"If you're going to open the hood and do a refinance anyway, you might as well take advantage of it and do a debt consolidation, if there are other things and you have the equity to do it," he notes.
Mike Rocha stresses that it's always helpful to talk to a financial advisor who can look at the big picture.
"A financial advisor will be able to look holistically at the person's financial situation, the individual, and then be able to apply a judgment (that) makes sense," he says.
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