Front Burner - Is a mortgage crisis on the way?

Episode Date: December 4, 2023

Millions of Canadians will soon feel the impact of jumps in interest rates as their mortgages come up for renewal. In some cases, their payments could go up by 40% or more.  What will happen to Canadians already struggling to make mortgage payments? What could the impact be on real estate prices?  And as banks set aside hundreds of millions more in reserves for bad loans, are there risks to Canada’s economy and financial institutions?  Ron Butler, mortgage broker at Butler Mortgage and host of the Angry Mortgage Podcast, explains.  For transcripts of Front Burner, please visit: https://www.cbc.ca/radio/frontburner/transcripts Transcripts of each episode will be made available by the next workday.

In the Dragon's Den, a simple pitch can lead to a life-changing connection. Watch new episodes of Dragon's Den free on CBC Gem. Brought to you in part by National Angel Capital Organization, empowering Canada's entrepreneurs through angel investment and industry connections. This is a CBC Podcast. Hi, I'm Damon Fairless. So, I've been losing sleep for the past few months. The other night, I was up until about 2 in the morning, going over my finances. For real.

Last March, when the Bank of Canada started hiking its key interest rate at record pace, mortgages also started ballooning. Now, I'm still a couple years away from having to renegotiate my mortgage, but the prospect of how much more I'm going to have to pay when I do renew it because of high interest rates? Man, it's been stressing me out. And I know I'm not alone. According to a report from Royal LePage, over 3 million Canadians are facing mortgage renewals

in just the next year and a half. So a whole lot of Canadian homeowners are going to be paying a whole lot more. All of this has prompted Canada's banks to set aside hundreds of millions of dollars more in reserve funds to cover potential losses from loans people can't pay back. So is Canada headed for a mortgage cliff? Or are we just headed for a lot of pain and stress as people try to figure out

how they're going to be paying their mortgages? Ron Butler's here with me. He's a mortgage broker with Butler Mortgage, and we're going to be talking about this. Hey, Ron, thanks for coming on FrontBurner. Hey, thanks for having me. I appreciate it. Okay. So for those folks out there who haven't bought a home, haven't dealt with a mortgage, let's talk basics. What is a mortgage renewal in Canada? What is a mortgage renewal? Okay. So you buy a house, you get a mortgage and the mortgage has two components essentially to it. It has an amortization. So amortization is say 30 years, 25 years. And that is the length of time that everyone plans on you having the mortgage paid to zero. Then you've got the five year or the three year or the two year, that's called the term

that is different than the amortization. So at the end of five years, you renegotiate your rate. You might've got, let's just go back in time for five years ago, you know, 2018, 2019. Rate was probably something like 3.49, 3.29. And your bank sends you a note and they'll say, hey, guess what? In the renewal date, which is three or four or five years from when you got that mortgage, is coming up. And on that date, here are all the options for new rates for you. And if you take your read and you take your pick and it's higher, it's a lot higher. Well, yeah, exactly. So let's talk about those rates because the Bank of Canada has been raising

its key interest rate at a record pace, boosting it from a quarter of a percent to 5% to try to rein in inflation. So tell me what those key interest rate hikes mean for folks who are in that renewal process or about to enter it? Sure. So you made exactly the right comment. The increases are unprecedented. Higher interest rates are needed to slow the growth of demand in the economy and relieve price pressures. The benchmark rate at 5%, the highest it's been since 2001. It's been raised 10 times since March 2022 in an effort to bring down inflation.

Looking forward, the central bank says it is prepared to increase the policy interest rate further. We have had many times when rates have been higher. We had a time in 1982 where there were a lot of 18% mortgage rates, okay? The houses were also only 189,000. So there's a big difference there, too. But yeah, the fastest this is the fastest, steepest, most radical increase in the history of Canadian interest and mortgage rates because we started at such an incredibly low number of 0.25. So, yeah, the numbers have gone through the roof. So this Bank of Canada prime rate is then converted into a bank commercial rate. That's always today 2.2% higher than the 5% rate we have at the Bank of Canada.

So your prime rate is 7.2. If you had a mortgage related to prime, let's say it's prime less 1%, you're now at 6.2. But you might have started at 1.45. So that is an incredible increase if you think about just number to number. So just for a very concrete example, I'm due to renew in a couple of years. And depending on the scenario where the interest rate lies, I'm looking at something, and it's hard to tell, I'm looking at something between 25 and 50% increase in my monthly mortgage payments. So how typical is that?

Well, if it were to happen today, you're quite correct. And now what it's going to be two years from now, none of us actually know. But if you were coming up for renewal today, you would experience something that's more than 50% in interest cost. Interest cost is going to double your payment because a portion of that payment always goes to pay off the mortgage pay down principle. Then you're going to experience something between a 35 to a 50% increase in payment. That's correct. Right. when we're looking at renewals too, is that some people are going to try to reduce the cost of their monthly payments, but it means that they're spreading out

the length of time overall over the years that they have to pay it off too, right? That is exactly right. And let me just give you a simple example. Let's say that you bought your house 10 years ago, you started with 30 year amortization, and now you're down to 20, but your interest rate is going up so significantly. You look at your renewal and you think, oh my God, my payment's going to go up 40%. What can I do? Well, the bank or the lender will normally,

it might be a credit union, could be anything, will say, well, one option is you're at 20-year amortization now. We can take you back to 30-year amortization and that would reduce your payment. Now, the downside to that is you're going to be paying off that mortgage much, much more slowly. It does, unfortunately, lead Canadians down the road of having bigger mortgages for longer. I mean, it was a wonderful world when interest rates were down around 1.59, which we may never see again.

But at 1.59, even on 25-year amortization, 80% of your payment went to pay down your mortgage. Now it's turning reverse and only 20% of your payment is paying off your mortgage. Okay. And I mean, we should point out that not all mortgage renewals are going to be disastrous for everyone. There's different mortgage situations, different life situations. But I guess what I'm interested in here is, can you give me a sense of what's coming in the next couple of years? How many mortgages are we expecting to come up for renewal? In the next 24 months, starting on the 1st of January next year, 45% of all the mortgages in Canada will renew. Wow, that's huge. So over the next couple of years, if someone can't pay their mortgage with these new rates, what are their options? What can they do? Well, they can do a lot of things. That re-amortization is the primary move. So lengthening the overall term of their mortgage.

Right. To reset the term of their mortgage, to reset the amortization on their mortgage, to reduce their payments. We're seeing that on a pretty consistent basis. Canadians are very, very resourceful about holding onto their homes. We've seen people rent out basements, rent out rooms. We've seen people go to the trouble of getting a side gig. You know, they've got their regular job and they're taking on other part-time jobs.

I mean, it is incredible how resilient Canadians are about holding on to that house. And let's also face this fact. If we're fortunate, people saw a, you know, they got a better job. They got promoted. They got more income coming into the household so that it could possibly be manageable to handle a 25, 30% increase.

It absolutely could be. A lot of other things have gone up in price as well. Presumably, though, there's going to be folks who aren't going to be able to meet that increase, whatever it is, and will be forced to sell, I imagine. Well, I imagine. Well, I was at a meeting just this week where a number of people in the meeting have related that their clients have had to sell their homes for exactly that reason. We have seen it in our own business. We've heard it from others.

And people just said, look, if I sell now, I can get some cash out because there is the other phenomenon we're experiencing in parts of Canada where the price of homes is dropping. So if you bought a house in 2021, it's sort of the absolute peak of the marketplace, then you might be seeing that that price is coming down. Okay. So let's go into the real estate market. I want to ask about that. If a lot of people ultimately have to sell and the high interest rates are making mortgages to buy another one so much more expensive, what can we expect to happen to the price of homes? Well, I think we're going to continue to see house prices come down. Prices have fallen in the last six months, but what we are absolutely seeing is that

these high rates make it difficult for people to buy a house. Is there any hope that the rates are going to go down to the rates that we saw a few years ago? Well, hope springs eternal, but my rational mind says absolutely not. That's not going to happen. I think everybody has realized that a Bank of Canada rate at a quarter of 1% has had pretty lousy results in terms of economic yo-yoing behind unmanageable rates and ultra low rates. And it's encouraging the consumer to do things in ways that are not necessarily helpful. You may never see a rate below 2% for a decade. But let's face facts. Right now, if you're being offered a 6% rate, 4% would look really good.

Really, really good. And we might see that by the fall of next year. I'm going to go. through Angel Investment and Industry Connections. Hi, it's Ramit Sethi here. You may have seen my money show on Netflix. I've been talking about money for 20 years. I've talked to millions of people and I have some startling numbers to share with you. Did you know that of the people I speak to, 50% of them do not know their own household income? That's not a typo, 50%.

That's because money is confusing. In my new book and podcast, Money for Couples, I help you and your partner create a financial vision together. To listen to this podcast, just search for Money for Couples. So we've been talking about housing prices, but I'm also curious what all this means for the rental market. The rental market has been a very sad and serious story. The cost of renting in Canada hit another record high. New tenants are now paying more than $2,100 on average. Renting a one-bedroom apartment in Vancouver now costs on average over $2,800 a month.

Rent in 2,700. Vaughan, just under 2,700. Mississauga, Etobicoke, and York, all 2,600 or more. From Victoria to Calgary, Kingston to Halifax, prices have soared, pushing student housing further out of reach. Certainly, we have all heard horror stories of friends, relatives, neighbours going to university and finding out that the student rental is like unmanageable, like it's so expensive. People like to say, no, no, that's to do with immigration. That's because we brought so many new people, new Canadians into the country. But believe me, if you're a landlord who's seen a 40% increase in their mortgage payment, you are incredibly motivated to try to find tenants who are going to pay more.

You are incredibly motivated to try to find tenants who are going to pay more. So, yeah, we can certainly lay some of it at the feet of these very much higher mortgage payments. You know, we've been talking on the show about Canada's housing crisis in general. And now, you know, we're presented with this scenario where we've got this huge number of mortgages renewing. I guess my mind goes to bad mortgages. And then I started thinking about the 2008 financial crisis where US banks had been giving out a ton of risky mortgages. People couldn't repay them. I mean, there were other factors, but getting saddled with losses from bad loans was a huge part of numerous banks in the American banking system collapsing. Are Canada's banks in any kind of danger here with this

current scenario? Well, we've seen in the last, just the last few days, we've seen almost all the big banks announce massive increases in something that's referred to as their loan loss provisions. So they're estimating just how many of their mortgages, car loans, credit cards, all their different types of lending that they do. They're estimating that the bad loans of people who will stop paying is going to radically increase in the coming months. Essentially, they're setting aside more of their profits to say that, hey, we think that there's going to be a lot more people who can't pay their loans. And in some cases, it was as high as 140% increase, 89% increase, 40% increase. So these are significant developments that show that banks

are concerned that there will be Canadians who don't pay their debts. That's bad news, but it's mostly bad news to us because our banking system is so well capitalized, so well run, because our banking system is so well capitalized, so well run. It doesn't even look slightly like what was going on in the States in 2006 and 2007 that led to the U.S. mortgage crisis. We have never underwritten mortgages that way. We don't have any products that look like that. And so my message is that I don't believe that we have anything to worry about in our banking system.

There's going to be some contraction, but we're not going to have to worry about the banks. We have to worry about ourselves. Right. That's what we got to worry about. But there's another concern here, right? So when people can't pay back the money that a bank's lent them, you know, the bank relies on the sale of the home to make its money back.

And I guess we were talking about the price of housing going down. So if the prices of houses drop too seriously, wouldn't it be tough for banks to recoup their costs? Or is that the reason for these loan loss reserves? It is part of the reason. It absolutely is. I would also suggest to you that right now, those banks with large car loan portfolios are looking at that very closely, probably more so than mortgages. We have an unbelievably low, even this quarter, we have an unbelievably low rate of default on mortgages in Canada. We are the best mortgage payers compared with so many countries. Nobody can stand up to unemployment to that great extent.

However, we have a system in Canada that for those who've made small down payments, those loans are insured, those mortgages are insured through CMHC or Sajan or Canada Guarantee, and the banks would recover any losses from those companies. For the loans and the mortgages that took place that were bigger mortgages where there were large down payments, well, in those cases, is normally a good deal of what we call a margin of safety. That is to say that the house is worth a million dollars and the mortgage is only $500,000. So house prices would have to decline fairly significantly for banks to be impacted in a major way. That's okay for the banks, but it's terrible for the human beings who might lose their homes. And, you know, that's what I think about every night.

So a couple of weeks ago, we were covering the Liberals' fall economic statement. And part of that was Finance Minister Chrysty Freeland introducing what she called the Canada Mortgage Charter. I want Canadians to get through this. I want Canadians to be able to afford their mortgages and keep their homes. That's where the government's new mortgage charter comes in. A series of guidelines for banks, including allowing temporary extensions of amortization periods so people can take longer to pay,

and exempting homeowners from a stress test when switching lenders at renewal. As I understand it, it's not legally binding. It's more of a list of guidelines that she's hoping banks will follow to make things easier for homeowners. What do you make of this charter? Sure. The most important thing I should say is that hopium is, you've got to stay off the hopium pipe. Hope is not a strategy and hope is not even a meaningful consideration when you're, you know, we're talking about legal contracts and banks. So almost everything Mr. Freeland mentioned in that Canadian Mortgage Charter is either recycled. So I guess it's good for the environment because it was already there. It's recycled or

it's unenforceable. And quite frankly, she's got another agency that her department works with called OSFI, the Office of the Superintendent of Financial Institutions, which is the actual bank regulator. And the actual bank regulator is telling banks, do not do a lot of these extended amortizations. Only do them when it's absolutely necessary. Make sure that you have adequate proof that there is financial hardship. So as much as Minister Friedland, you know, is talking about this, these various things inside that charter, that people would have easy access to extended amortizations, that banks would waive penalties if they had to sell the house, that there wouldn't be any interest on interest. Well, probably none of those things are

going to happen. I mean, the banks will offer extended amortizations when the customer can clearly prove there is hardship. They've been doing it. They will waive penalties when it's clear that a house is being sold with very little proceeds. But let me tell you this, there is no penalty gets waived if you sell a house and you have $200,000 coming back from it. There's no bank that's waiving a penalty and no bank expects to waive a penalty and the regulator doesn't expect to waive a penalty. So a lot of the stuff that you're hearing there, well, I've just got to say it straight. I mean, there's a certain amount of political theater that's going on there. So it isn't a promise to protect homeowners.

I think it's a suggestion. It's not law. It's not mandated. And there's another regulator who says that they would prefer that some of the things not even happen. So Ron, give me a forecast here. How much pain are we in for in the next few years? Well, a lot of that has to do with interest rates. I mean, if interest rates fall quickly, they fall a lot, like I'm talking 2% over the next 16 or 18 months, then it's going to take a lot of the burden off some of these people who are looking at six or sometimes 7% rates on renewal, and that's going to be helpful. But absolutely, every single person in Canada is going to notice

that their cost for owning a home or renting, it's going to be up. And that is a sad commentary on our society. You know, Canada, by and large, is a pretty cold country in the winter. People need a roof over their heads. Realistically, we have let house prices and rents just run away. And a group of people have enjoyed that benefit. If you bought a house in 2010, you probably think the run-up is not such a bad idea. But for everybody who wants to get into the market today, for people who bought in the last couple of years, it's been amazing, the cost of these homes, the size of these mortgages. I'll just give you a quick analogy. Every single home from the poorest neighborhood to the most expensive neighborhood, every single home in Chicago, on average, costs 65% less than in the

GTA. That's huge. That's a huge amount. People say, oh, nobody wants to live in Chicago. Well, I kind of like Chicago. I've been there a couple of times. I think it's a great town. And it's a very big city and it's full of head offices and it's full of people working at sophisticated jobs like Toronto. But somehow, even in the nicest neighborhoods

and right down to the tough neighborhoods, price of homes, 65% less. All right, Ron. Thanks so much. I really appreciate you coming on. Thank you so much. I really enjoyed it. Thanks for having me.

All right, that's all for today. I'm Damon Fairless. Thanks for listening to FrontBurner. And I'll talk to you tomorrow.