Even with expected rate cuts, mortgage payments will continue to rise for years: BoC research

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Despite anticipated Bank of Canada interest rate cuts later this year, mortgage borrowers will continue to face higher debt-servicing costs for several years.

That’s according to a research report released by the Bank of Canada that did a deep-dive on mortgage debt and payments, taking into account some of the intricacies of the mortgage market, including the distribution of fixed vs. variable rates.

“Under a range of hypothetical policy rate scenarios, our model predicts that, even if rates begin to fall, the required payment rate on mortgage debt will continue to climb in the coming years,” the report’s authors, Fares Bounajm and Austin McWhirter, wrote.

“The impact of the tightening that began in early 2022 will continue to gradually materialize over the next few years,” they added. “Therefore, barring a sudden drop in the policy rate…debt-servicing costs will likely continue to climb for many households, exerting a drag on discretionary spending.”

The report delved into the complexities of understanding the full impacts monetary policy changes have on the mortgage market. The authors noted that most structural macroeconomic models “do not account for some of the intricacies of the mortgage market’s structure.”

While that’s generally not a problem when monetary policy changes are slow or infrequent, it results in “shortcomings” in situations where interest rate changes are very rapid and occur over an extended period, such as the current rate-hike cycle.

In these cases, researchers need to rely on “microsimulations initialized using detailed microdata on individual mortgages” to fully understand the timing of monetary policy pass-through, the authors say.

“For example, if the proportion of households holding variable payment mortgages increases, then monetary tightening will pass through to household finances more quickly,” they wrote. “And if long-term fixed contracts grow as a share of outstanding mortgage debt, rate increases may take longer to have their full impact on consumer spending.”

Monetary policy tightening reduces household debt in the long run

As part of the research, the report noted that, despite higher interest costs for borrowers in the short term, monetary policy tightening results in lower household debt over the long run.

Using the scenario of a temporary interest rate shock of 100 basis points to the policy rate, the result is first a drop in homebuying and demand for new loans.

“As a result, household debt also declines gradually,” the report reads. “The household debt-to-income ratio initially rises as income falls. However, the ratio falls below the model’s steady state after about eight quarters due to household deleveraging.”

“This suggests that monetary policy tightening reduces household indebtedness in the long run,” it concludes.

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