With 60 per cent of all outstanding mortgages coming due in the next three years, homeowners will be facing a "payment shock" that could be significant and a tail risk for Canadian banks, a new report says.
RBC Capital Markets analyst Darko Mihelic wrote in a research note released on Monday that 60 per cent of outstanding mortgages at Canadian chartered banks are coming due in the next three years, and "that payment shock (the increase in payment at renewal) could be significant and represents a tail risk for 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 wrote.
According to RBC's analysis, more than $186 billion of mortgages are set to renew in 2024. At today's interest rates, the weighted average payment shock for those renewing next year would be 32 per cent. In 2025, RBC says there are approximately $315 billion of mortgages set for renewal, with many being variable-rate mortgages. The weighted average payment shock for those renewing in 2025 is expected to be 33 per cent, "but with a wider distribution of outcomes," Mihelic wrote.
The Bank of Canada's benchmark interest rate currently sits at 5 per cent, the highest level since 2001. RBC notes that a 100 basis point decline in mortgage rates would reduce the payment shock for those renewing in 2025 from more than 30 per cent on average to more than 20 per cent on average.
But reducing the payment shock for those renewing in 2026 would require a steeper decline in interest rates. The year 2026 sees the largest proportion of variable-rate mortgages up for renewal, which Mihelic says means that "unless rates fall meaningfully, the payment shock could be as high as 48 per cent on a weighted average basis."
"Variable-rate mortgagors are set to see significant payment shock, perhaps as high as 84 per cent by 2026 if interest rates do not decline. Interest rates would need to decline significantly to 'save' this cohort," Mihelic wrote. Bringing the payment shock to 20 per cent would require the Bank of Canada benchmark rate to fall to 0.25 per cent by July 2026, something Mihelic says would be "perhaps an unreasonable expectation at the moment."
The Bank of Canada has been on an aggressive tightening campaign since March 2022, hiking its benchmark rate 10 times as it tries to tame persistent inflation. Last week, the central bank held its key rate at 5 per cent, but left the door open to further hikes over concerns about stubborn inflation.
Alicja Siekierska is a senior reporter at Yahoo Finance Canada. Follow her on Twitter @alicjawithaj.