How severe could the upcoming mortgage renewal shock be?

Canada will see nearly $1 trillion in mortgage renewals due by 2026, which could impel a massive increase in average monthly mortgage payments, according to Dylan Smith, senior economist at think-tank Rosenberg Research & Associates.

In turn, the increases could lead to what Smith described as a “demand shock” that would place significant stress “on the housing market in particular and the economy in general.”

“Given that the vast majority of fixed-rate mortgages and fixed-payment, variable-rate mortgages had locked in low interest rates before or in the early stages of the 2022/23 hiking cycle as consumers shifted away from fully variable mortgages, renewals will force mortgage holders onto much higher average interest rates,” Smith said.

The volume due for renewal in 2026 represents approximately two-thirds of mortgages by value, Smith said. “Based on the share of households due to renew, we calculate the average monthly mortgage payment will rise by a further 15% by the end of 2024, 30% by the end of 2025 and 45% by the end of 2026,” Smith warned.

A recent analysis by RBC Capital Markets analyst Darko Mihelic noted that these trends are amplifying the dangers faced by the banking sector, with higher payments come renewal time being a “tail risk to Canadian banks.”

“Unless there are significant declines in interest rates, we believe that credit losses will inevitably rise, perhaps significantly in 2025 and beyond,” Mihelic said. Mihelic estimated that monthly mortgage payments could increase by as much as 48% by 2026.

Still, a not-insignificant share of mortgage holders will find themselves with no choice but to enter into default, Smith said. “Banks have already significantly increased loan-loss provisions in anticipation of rising delinquencies (up $7 billion in the first three quarters of 2023, from $3.2 billion over the whole of 2022),” Smith said.

“Many, including the Bank of Canada, have pointed out that delinquency rates are still at record lows. But that’s because most renewals haven’t happened yet. Historically, there is a two-year lag between policy rates and mortgage defaults, meaning we’re in for a steady rise in defaults starting in early 2024.”