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Home owners with variable-rate mortgages face difficult squeeze as interest rates rise, house prices drop, Bank of Canada warns

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Homes on Sherman Brock Circle in Newmarket, Ont. on Mar 30, 2021.Fred Lum/the Globe and Mail

Canada’s financial system should be able to weather a period of heightened stress, but many recent home buyers could experience a “painful” squeeze as interest rates continue to rise, the Bank of Canada’s second-in-command said Tuesday.

In a speech in Ottawa, senior deputy governor Carolyn Rogers said long-standing vulnerabilities in Canada’s housing market worsened through the COVID-19 pandemic as home prices soared and buyers increasingly relied on variable-rate mortgages, which are linked to the central bank’s benchmark lending rate.

Now that interest rates are rising and home prices are falling, many of these home buyers are experiencing a nasty adjustment, Ms. Rogers said.

The most common variable-rate product has fixed monthly payments. With every interest rate hike, more of the borrower’s monthly payment goes toward interest. However, when the monthly payment no longer covers any principal, the borrower hits what is known as a trigger rate, and their monthly payment rises. In some cases, the lender allows the borrower to shift the interest onto the principal, which increases the size of the mortgage.

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Fifty per cent of these variable-rate mortgage holders have already reached their trigger rate, according to estimates from a new Bank of Canada research paper published Tuesday. That share will rise to 65 per cent by the middle of next year as the central bank continues to hike interest rates to rein in inflation.

What is your mortgage trigger rate? This calculator helps you estimate it

“The bottom line is that mortgage costs for some Canadians have already increased, and they will likely increase for others in time, making home ownership more expensive.” Ms. Rogers said.

About 670,000 variable-rate mortgages have been issued since the start of the pandemic, according to the Bank of Canada. Variable-rate mortgages accounted for around 50 per cent of all mortgages issued since mid-2021, compared to an average of 20 per cent in the years before the pandemic.

“This is not a large share of households, but it is larger than it would have been based on historical trends,” Ms. Rogers said.

Borrowers have sought the variable-rate products because borrowing costs have typically been cheaper than fixed-rate mortgages. Part of the motivation was that federal banking rules require borrowers to prove they can make their monthly mortgage payments at an interest rate at least two percentage points higher than their actual mortgage contract.

Homes Bellagio Crescent in Mississauga, Ont.Fred Lum/the Globe and Mail

Problems in the mortgage market can infect the broader financial system if borrowers default on payments. Ms. Rogers said Canada’s banking system is in a good position to handle potential shocks, thanks to reforms following the 2008-09 financial crisis that increased capital and liquidity requirements for lenders and bolstered mortgage stress tests.

Moreover, the central bank is “not expecting a severe economic downturn with the kind of large job losses typical of past recessions,” she said.

But tens of thousands of homeowners will be pinched as interest rates continue to rise. The Bank of Canada is widely expected to raise interest rates again on Dec. 7, either by a quarter-point or half-point. Financial markets expect the bank’s benchmark interest rate to reach 4.25 per cent by early 2023, up from 3.75 per cent today.

The research paper noted that over the past decade, few borrowers had to deal with the trigger rate because interest rates have been relatively low since the global financial crisis.

“But with the rapid increases in the policy interest rate by the Bank of Canada since March, 2022, variable-rate mortgage borrowers have faced historically large interest rate increases that make reaching their trigger rate a significant possibility,” said the paper authored by Stephen Murchison, Advisor to the Governor, and economist Maria teNyenhuis.

Major lenders have downplayed the trigger rate and have repeatedly said only a small subset of their borrowers risk reaching this threshold. The research paper is the first time the central bank has tried to quantify the effects of the higher interest rates on variable-rate mortgage holders.

The researchers estimated that these mortgages account for 13 per cent of all outstanding mortgages. They said this estimate does not account for borrowers proactively making a lump-sum payment or taking other steps to avoid reaching their trigger rate.

Outstanding mortgages include fixed-rate mortgages for which the monthly payment and interest cost remain the same for the term of the loan. It also includes variable-rate mortgages with variable payments for which the monthly amount changes with fluctuations in the central bank’s benchmark interest rate.

The Bank of Canada paper found that variable-rate mortgages now account for about one-third of all outstanding mortgage debt. That compares to one-fifth in 2019.

The central bank is raising interest rates to slow consumer price growth. It does not specifically target home prices, but Ms. Rogers suggested the bank is quite happy to see those prices fall. Nationally, home prices are down by around 10 per cent from the peak in February.

“We need lower house prices to restore balance to Canada’s housing market and make home ownership more affordable for more Canadians,” Ms. Rogers said.

So far, however, rising interest rates have actually made homes less affordable, with rate increases more than offsetting home price declines. Royal Bank of Canada’s national aggregate affordability measure reached its worst-ever level in September.

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Bank of Canada policy will ‘hit home’ in 2023: David Rosenberg

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The Bank of Canada may be signalling a possible end to its months-long aggressive interest-rate hike cycle, but economist David Rosenberg said next year will see the lagging impact of 2022’s monetary policy “hit home” for Canadians.

“Next year is the payback,” Rosenberg, chief economist and strategist at Rosenberg Research and Associates Inc., said in an interview with BNN Bloomberg.

“2022 was the year of the sharp run-up in rates, 2023 will be the year where the policy lags from those rising rates hit home.”

He made the comments Thursday, a day after the Bank of Canada raised its overnight lending rate by 50 basis points to 4.25 per cent, as the central bank continued with its approach to bringing down inflation.

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Rosenberg predicted a “severe recession” for Canada next year based on the rate hike cycle, calling for a “triple whammy” with economic impacts compounded by high levels of household debt, a housing bubble and ripples in the global economy.

Possible spillover effects from the interest rate cycle could be felt, Rosenberg said, as banks may constrain the availability of credit and spending drops across various sectors.

Based on the latest rate increase, Rosenberg said he predicts at potentially one more rate hike from the bank before a pause. Once inflation starts to come down, Rosenberg said he thinks the central bank may start to cut rates, possibly in the second half of 2023.

“The next stage is going to be waiting for the inflation to come down, which I think it will, and the recession is going to catch a lot of people by surprise,” he said.

A similar pattern may play out in the U.S., but Rosenberg said Canadians are more exposed to higher interest rates through variable-rate mortgages and because more consumer credit is tied to short-term interest rates.

“As bad as it’s going to be in the U.S., and believe me, it’s not going to be a pretty picture there, I think the Canadian situation in the next year is going to be clouded at best,” he said.

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CRTC rejects Telus’ request to charge credit card processing fee for some services

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The Canadian Radio-television and Telecommunications Commission ruled Thursday that Telus is not able to charge a credit card processing fee for regulated home telephone services.

This ruling applies to Alberta and B.C. services that are regulated by the CRTC, which are generally home telephone services in certain smaller communities.

Since Oct. 6, most Canadian businesses, except in Quebec, can charge their customers a fee for credit card transactions, following a class-action lawsuit filed by retailers against Visa, MasterCard and card-issuing banks.

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Quebec is not included in this decision due to the province’s Consumer Protection Act, which prohibits the application of such surcharges.

On Aug. 8, Telus filed an application with the CRTC to introduce a credit card processing fee of 1.5 per cent, plus taxes, for payments made with a credit card.

On. Oct. 17, Telus began to charge the fee to clients paying by credit card in areas where services are not regulated by the CRTC, which includes its wireless and internet customers outside of Quebec.

Telus does not need to ask for the CRTC’s approval to add the surcharge to its unregulated services but the organization said it is “very concerned” about this practice as it goes against affordability and consumer interest.

“We heard Canadians loud and clear: close to 4,000 of you told us that you should not be subjected to an additional fee based on the method you choose to pay your bill,” Ian Scott, chairperson and CEO of the CRTC, said in a statement. “We expect the telecommunications industry to treat Canadians with respect and do better.”

The CRTC said, with this ruling, it is sending a “clear message” to Telus and other telecommunications service providers that are thinking of imposing a fee like this one on their customers.

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Stock market news live updates: Stocks close mostly lower as selling pressure continues

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U.S. stocks extended this week’s downtrend Wednesday to close a choppy session with losses as the prospect of sustained higher rates and slowing growth continued to plague investor sentiment.

The S&P 500 (^GSPC) slumped 0.2%, ending a fifth straight day lower, while the Dow Jones Industrial Average (^DJI) capped trading at the flatline. The technology-heavy Nasdaq Composite (^IXIC) declined 0.5%.

In commodities markets, oil extended losses to close around $72 per barrel after a decline of roughly 10% this week to the lowest level since January.

“Fears are growing that economies are in for a rough time ahead as feverish inflation and the bitter interest rate medicine being used to bring it down take effect,” Hargreaves Lansdown senior investment and markets analyst Susannah Streeter said in a morning note, pointing also to recession warnings from U.S. bank bosses and gloomy trade data in China. “Despite today’s easing of restrictions, it’s clear China’s Covid nightmare is not at an end.”

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A chorus of downbeat remarks from Wall Street leaders on Tuesday further weighed on already slumping sentiment this week as many expressed concerns over the toll of inflation and elevated interest rates on U.S. consumers.

JPMorgan Chief Executive Officer Jamie Dimon said the $1.5 trillion in excess savings across Americans’ bank accounts were being eroded by rising prices, while warning the dwindling disposable cash may “derail the economy and cause this mild or hard recession that people are worried about.” Bank of America chief Brian Moynihan echoed a similar message, indicating that while consumers are still spending money, the pace is beginning to slow.

Meanwhile, Goldman Sachs (GS) CEO David Solomon projected stocks will barrel lower in 2023 and placed the probability of a soft landing at a mere 35% – a view at odds with in-house economists at his investment bank, who anticipate in their baseline forecast that the U.S. will narrowly avoid a recession next year.

“There’s a very reasonable possibility that we could have a recession of some kind,” Solomon said in an interview at the Wall Street Journal’s CEO Council Summit Wednesday afternoon.

David Solomon, Chief Executive Officer of Goldman Sachs, speaks during the Global Financial Leaders Investment Summit in Hong Kong, China November 2, 2022. REUTERS/Tyrone SiuDavid Solomon, Chief Executive Officer of Goldman Sachs, speaks during the Global Financial Leaders Investment Summit in Hong Kong, China November 2, 2022. REUTERS/Tyrone Siu
David Solomon, Chief Executive Officer of Goldman Sachs, speaks during the Global Financial Leaders Investment Summit in Hong Kong, China November 2, 2022. REUTERS/Tyrone Siu

Reports that China’s government will scale back some zero-COVID rules appeared to underwhelm investors weighing easing restrictions against economic data out of the nation that showed falling imports and exports in November.

Back in the U.S., shares of Campbell Soup (CPB) rose nearly 6% after the canned goods producer reported earnings that beat Wall Street estimate and raised its full-year forecast. The company said sales of soup in the U.S. jumped 11% due to increases in demand for ready-to-serve soups, condensed soups and broth, reflecting a recent shift among consumers to value food purchases as inflation continues to weigh on households.

Shares of Apple (AAPL) sank 1.4%, one day after Bloomberg News reported the iPhone-maker scaled back ambitious self-driving plans for its future electric vehicle and postponed the car’s release data to 2026. Bloomberg also reported Wednesday morning that mobile industry bellwether Murata Manufacturing expects Apple will further reduce production plans for its iPhone 14 due to weakening demand.

Online used car retailer Carvana (CVNA) was also in the spotlight after plunging about 43% after the company’s biggest creditors reportedly signed an agreement to cooperate in potential restructuring negotiations as the company faces growing bankruptcy risk.

Investors await another round of economic data as the Federal Reserve’s final rate-setting meeting this year approaches. Readings on weekly jobless claims, producer price inflation, and consumer sentiment are due out later this week, but the most important data point for clues on the Fed’s direction for interest rates is the Consumer Price Index (CPI) out Tuesday, the same day U.S. central bank officials kick off their last two-day rate-setting meeting of 2022.

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