Banking regulator in Canada warns of shock to housing payments by 2026

Canada’s banking watchdog has warned that many homeowners who took out mortgages when rates were near zero during the pandemic will soon face reckoning when those loans are renewed.

The “payment shock” facing some borrowers is among the most significant risks currently in the financial system, according to the latest risk outlook from the Office of the Superintendent of Financial Institutions, released Wednesday.

The regulator said 76 percent of residential mortgages outstanding as of February will be renewed by the end of 2026. Most worrying are the 15 percent of variable-rate mortgages with fixed payments. Some of these loans are negatively amortized, meaning the regular payments no longer cover the entire interest costs because rates have increased so quickly, so the principal balance increases.

Eventually, these borrowers must make lump sum payments or accept much higher monthly expenses, the regulator said.

“We expect payment increases to result in a higher frequency of residential mortgage loans being delinquent or in default,” OSFI said.

Housing risks are a long-standing concern in Canada, as households face high housing prices, high interest rates and inflation levels that eat into a greater share of their take-home pay .

The report adds that the labor market remains relatively strong, but any weakness could significantly change the risk landscape.

The Bank of Canada’s benchmark overnight funding rate has been 5 percent since last July, the highest level in more than two decades. This is crucial because many Canadians have mortgages with interest rates tied to the central bank rate. The longer rates remain high, the longer these households will face financial difficulties.

“The mouse in the snake”

Peter Routledge, the superintendent of financial institutions, said the issue of adjustable rate mortgages with fixed payments is like a “mouse in the snake”: it’s a big problem that banks are grappling with. to digest slowly, but it still has the potential to lead to disproportionate consequences. losses.

“The good news is that banks and Canadians are dealing with this issue early, and part of the reason we’ve been talking about it is to drive early action,” Routledge said in an interview on BNN Bloomberg Television.

The OSFI report also cites security risks related to hostile foreign actors, wholesale credit and liquidity as potential problems in the system. The regulator expressed concern that the security and integrity of financial institutions are threatened by fraud and money laundering.

The regulator plans to address concerns about foreign interference through a new group tasked with ensuring banks and other financial institutions address national security threats.