By Dylan Smith

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David Rosenberg: Canada's menacing mortgage math means crisis looming Back to video

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The macroeconomic math relating to Canada’s looming wall of mortgage renewals should be terrifying for the Bank of Canada. A large increase in average monthly mortgage payments will arise from the nearly $1 trillion in renewals due by 2026, triggering, in turn, a large demand shock and putting stress on the housing market in particular and the economy in general. The central bank will need to ease aggressively before the shock strikes to avoid turning a slowdown into a crisis, positioning Government of Canada bonds for outperformance in 2024.

It has been widely reported that around two-thirds of the Canadian mortgage market will renew their terms between 2024 and 2026. 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.

Mortgage renewal cliff ahead

This looming “mortgage renewal cliff” is common knowledge in Canada, but nobody has followed the macroeconomic math through to its full conclusion. We triangulated various data sources to trace the impact of mortgage renewals through the system. While perfect accuracy is impossible, the broad direction and magnitude of the impact are both knowable and alarming.

Combining the data from the Bank of Canada’s most recent Financial Stability Review with Canada Mortgage and Housing Corp. (CMHC) data on average balances, we confirm that around two-thirds of mortgages (by value) will renew by 2026. The distribution is somewhat backloaded, with a bit more than half coming in 2024 and 2025, and the remainder in 2026. We can use the rise in average monthly mortgage payments that has already happened since the beginning of the hiking cycle to get a sense of how this will affect consumers.

Mortgage payments will rise

In February 2022, the average monthly mortgage payment was $1,460. It’s now above $1,900, an increase of more than 30 per cent, according to the latest CMHC data. Since that figure includes a sizable number of floating-rate mortgages that fixed their interest rate in early or mid-2022 (partway into the hiking cycle), that’s a conservative starting point for assessing the impact of coming renewals (who will face even higher rates). Based on the share of households due to renew, we calculate the average monthly mortgage payment will rise by a further 15 per cent by the end of 2024, 30 per cent by the end of 2025 and 45 per cent by the end of 2026.

Economy will take big hit

Where the math gets truly menacing is when one aggregates the rise in individual payments to get the macroeconomic implications. If households are forced to funnel more of their monthly income into mortgage payments, that means less for discretionary spending on things such as white goods, restaurants and holidays. Based on the share of total households with a mortgage, this hit to per-capita discretionary income is equivalent to a shocking 20 per cent reduction in effective aggregate national disposable income by the end of 2026. That’s an enormous hit to demand.

Of course, this calculation represents something of a theoretical “upper bound” to the impact on demand because many households will simply not be able to absorb such an increase in mortgage costs, and the pressure from renewals will have to escape through other valves.

Some households will opt to restructure their mortgage payments, deploying their remaining “excess savings” to reduce principal and contain monthly payments (mortgage renewals are one possible explanation that the Bank of Canada itself has offered for the fact that Canadians are not spending down excess savings in the same way that Americans are).

Other households will downsize, meaning that the housing supply on the market is due to rise (along with demand for lower-priced units). The downward pressure on house prices will intensify, and the recent modest declines are only the beginning of this process.

Mortgage defaults to rise

A final, smaller group of mortgage holders will have no choice but to default on their mortgage obligations. 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). 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.

If we can do this math, the economists at the Bank of Canada can, too (with better data and higher accuracy to boot). It’s therefore very hard to picture the governing council not being aware of the storm on the horizon, and not concluding that rates will need to ease in anticipation of the mortgage renewal cliff to avoid a deep and prolonged crisis (rather than a mild corrective recession).

That means the central bank will need to switch posture relatively soon — we think in the first half of 2024. The process of making that change in posture will be eased by already stagnant demand and continuing disinflation. We don’t think markets have fully realized the degree of easing that will be needed yet (or the likely timing), and we don’t think investors are prepared for the differential between Canadian and U.S. rates to substantially widen (the United States Federal Reserve is likely to stay on hold longer than the Bank of Canada). That makes us optimistic on Government of Canada bonds in both an absolute and relative sense, while the case for loonie depreciation is strong.

Dylan Smith is a senior economist at independent research firm Rosenberg Research & Associates Inc. founded by David Rosenberg. To receive more of David Rosenberg’s insights and analysis, you can sign up for a complimentary, one-month trial on the Rosenberg Research website.