As noted on the Canada Mortgage and Housing Corporation (CMHC) website, interest rates of 6% or 7% are not rare in Canadian history. It’s just that for the current generation of mortgage borrowers, after decades of low rates, this is a very new situation. 

An estimated 2.2 million mortgages or more will have to be renewed at higher rates in the next two years. And that’s on top of the 878,000 or so that were up for renewal last year. 

If you are in this situation, it could put some stress on your personal finances. Here are a few guidelines to help you mitigate that stress. 

First, take stock of the situation 

As homeowners who had to renew their mortgages in 2023 or who have variable rates already know, slightly higher interest rates can translate into monthly payments that are… significantly higher. 

The following graph illustrates this phenomenon. We can see that for a $300,000 mortgage, for example, monthly payments can rise by hundreds of dollars when interest rates increase, as they have in the past two years.  

It is important to note that this additional cost is nothing but interest. In particular, this means that if you have a variable-rate mortgage (as one in five borrowers do) but a fixed monthly payment, the portion of each payment that goes to paying down the principal drops as the rates rise. It may even get to the point where the monthly payments won’t cover the interest. This is called the “trigger rate.” At that point, any unpaid interest is added to your loan, which just keeps growing larger. This situation is called “negative amortization.” 

But rest assured, there may be a glimmer of light at the end of the tunnel. 

Understand the context

The majority of economists are not predicting any new rate hikes by the Bank of Canada between now and next March, and many anticipate a decrease of about 1% by the end of the year. Note, however, that these are predictions, not certainties. 

As well, last fall the Canadian government unveiled a “Canadian Mortgage Charter” setting out relief measures that the government expects financial institutions to offer clients who might find themselves in a tough position. What does that mean? That it might be worthwhile to get some advice and have a talk with your financial institution to determine the best choices.  

Options to consider include the following: 

Extend the amortization 

Extending the amortization, i.e., the number of years over which a loan repayment is spread, is an easy way to reduce monthly payments, as we can see here. In the long term, the total interest cost will be higher because more payments are made, but in the short term, it could give you some relief. 

The new Canadian Mortgage Charter expects financial institutions to allow temporary extensions of the amortization period, including for “at risk” mortgage holders. Nonetheless, be aware that, in principle, mortgages insured by the CMHC have a maximum amortization period of 25 years. 

Make prepayments

Most mortgage contracts include the possibility of making lump sum payments on the principal up to a certain percentage of the loan (for example, 15%) before the end of the term, with no fees or penalties. If you have a large sum on hand – in a tax-free savings account (TFSA), for instance – you might consider using it for a mortgage prepayment. The Canadian Mortgage Charter expects financial institutions to waive the fees and costs that would otherwise be charged for relief measures. It remains to be seen what situations that will apply to in practice. 

Shop around

A frequent recommendation is to “shop around” lending institutions to find the best rate. Be aware that the new federal government charter expects financial institutions not to require insured mortgage holders (see below) to demonstrate their ability to handle higher payments by passing the famous “stress test” when renewing. Thus, they won’t have to requalify when switching lenders. 

Choose the rate type, contract type and term

A mortgage can have a fixed rate, which means the interest rate and monthly payments are “frozen” for the term of the contract, or a variable rate, in which case the interest cost varies based on the Bank of Canada key interest rate. It can also be “closed,” i.e., you must comply with the term of the contract, or “open,” which allows you to repay the loan at any time. Finally, the contract can have a term of anything up to 10 years. Each combination of rate type, contract type and contract term will have a different interest rate. Should you opt for the predictability of a fixed rate over several years, even if it means not benefitting from a future drop in interest rates? Or, on the other hand, count on interest rates decreasing? The answer depends on your financial situation and your tolerance for uncertainty. 

The insurance question

When negotiating a mortgage, you must consider two types of insurance. The first, generally offered by the CMHC, is mandatory if your down payment is less than 20%: it protects the financial institution in the event that you default on your mortgage. The loan is then said to be “insured.” It isn’t necessary to insure your mortgage if you have a large enough down payment, but did you know that you can if you want to? In some circumstances, that might get you a better rate from your financial institution and allow you to save more in interest than the insurance costs you. 

The second type is life insurance that would be used to pay off the balance if you were to die. In this case, even though it might be convenient to purchase the insurance from the lending institution, be aware that nothing prevents you from going to any insurer of your choice instead. One main difference is that in the first case, the insured amount would decrease as you repay the principal, but your monthly payments would stay the same. In the second case, the insured amount would stay the same: if you were to die, the insurance benefit could be used not only to pay off the mortgage, but also for other needs. As well, insurance purchased separately might cost less. To find out more, talk to your advisor. 

What about reverse mortgages? 

One last point is for homeowners who have paid off their mortgage, but who need some cash to cover expenses. This is notably the case for some retired individuals whose home is their principal asset. There is a financial product known as a “reverse mortgage” that involves borrowing money using a percentage of the property’s net value as collateral. This loan will bear interest, but only has to be repaid when the house is sold, or when the owner moves out or passes away. It is important to understand that this type of mortgage is complicated and expensive, is considered to be a last resort and, above all, is also affected by the high interest rates we are experiencing. If you are interested in exploring this option, be sure to get good advice. 

As we can see, contracting or renewing a mortgage involves many important decisions in today’s uncertain economic environment. Your advisor is your best ally for help in meeting this challenge.