What is Mortgage Payment Shock and Why are Canadians Worried About It?

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A recent Toronto Star article about a report released by RBC analysts has raised some concerns for homeowners. The report, titled “Canadian Banks: A review of mortgage payment shock,” revealed that more than $900 billion in mortgages at Canadian banks are set to renew in the next three years. It disclosed that “around 60 per cent of mortgages at Canadian chartered banks are set to renew between now and 2026, hurting banks’ profits and homeowners’ wallets amid soaring borrowing costs.” This means that some borrowers will see their mortgage payments rise by nearly half at their next renewal.

So what exactly is mortgage payment shock? The term refers to the significant and sometimes unexpected increase in a homeowner’s monthly mortgage payment at the time of renewal. This spike results from several factors, causing financial distress for those who are not prepared for it.

There are four common causes of mortgage payment shock:

Adjustable-Rate Mortgages

Also known as ARMs, adjustable-rate mortgages are one of the most frequent culprits. With ARMs, interest rates can fluctuate following an initial fixed-rate period, resulting in higher monthly payments.

Escrow Account Adjustments

When you make your mortgage payments, some of the money goes towards property taxes and homeowner’s insurance. These funds are kept in a special account called an escrow account. If these expenses increase due to rising property values or insurance premiums, it can lead to a sudden payment shock.

Changes in Mortgage Terms

If refinancing or restructuring a mortgage is required, it can alter the original terms and conditions. This can lead to higher monthly payments.

Economic Factors

Changes in the economy, like inflation or higher interest rates, can affect how much you pay for your mortgage.

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What’s Causing Canada’s Impending Wave of Mortgage Payment Shock?

Economic factors, specifically rising interest rates and inflation, are at the root of the problem. Let’s break down some of the numbers.

Over half of Canadians are choosing three-year, fixed-term mortgages, which are expected to renew at 6-8 per cent. In November 2019, that interest rate was 2.84 per cent.
More than $186 billion in mortgages are set to renew in 2024. With today’s interest rates, the expected payment shock would be 32 per cent.
In 2026, $400 billion in mortgages are renewing, with payments rising as much as 48 per cent. This will especially affect those with variable-rate mortgages.
Payments are expected to increase by 20 per cent, even if the Bank of Canada’s key interest rate drops to 0.25 per cent by July 2026. The benchmark interest rate is currently 5 per cent, which is the highest rate since 2001. The increases were made in an attempt to curb inflation.

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Are There Ways to Prepare for Mortgage Payment Shock?

There are some ways that homeowners can prepare and plan.

Create a detailed budget for all your housing expenses. Include possible increases in property taxes, insurance premiums and utility costs. This will help you make sure you can absorb these financial changes.
It’s a good idea to have an emergency fund. Try to save enough money to cover unexpected home costs or higher mortgage payments. This will provide a cushion during challenging economic times.
Consider choosing a fixed-rate mortgage instead of an adjustable-rate mortgage to avoid uncertain interest rate changes.
To make sure your homeownership plans match your long-term financial goals, consult a financial advisor. They can help you make informed decisions about mortgage terms and options.

Right now, Canadian banks are working to lower the impact of payment shocks. Clients have choices to increase monthly payments, switch to a fixed-rate mortgage, make a lump sum payment or extend the amortization period (the length of time it takes to pay off the mortgage in full).

The Office of the Superintendent of Financial Institutions, Canada’s biggest banking regulator, has instructed major banks to set aside billions of dollars in rainy-day funds for potential debt defaults. Banks have responded by nearly tripling the amount they typically set aside for bad loans compared to the third quarter of 2022.

Mortgage payment shock is a significant cause for concern for homeowners but it’s not an impossible challenge. To be ready for potentially higher mortgage payments, understand what causes them and plan your finances wisely.