While Canadian mortgage arrears have further to rise, a new report from BMO suggests they are unlikely to reach their long-term average.

The arrears rate, which tracks mortgages delinquent by three months or more, has been gradually increasing over the past year, but remains historically low, according to the Canadian Bankers Association.

As of April, the rate fell to 0.18% from 0.19% in March, where it had held steady for three months. This translates to just 9,252 mortgages in arrears out of over 5.02 million.

The national arrears rate has risen from a low of 0.14% in 2022, but remains below its recent peak of 0.27% reached in June 2020, and significantly lower than the all-time high of 1.03% in 1983.

Of course, not all regions of Canada are sharing the same experience.

Saskatchewan is experiencing a significantly higher arrears rate, hovering near the 0.60% mark for the past four months.

At the other end of the spectrum, Ontario has the country’s lowest delinquency rate at 0.13%, followed by British Columbia at 0.16%.

“For the first time since the financial crisis, home loan defaults in Canada are mounting and look to move higher on rising joblessness, resetting mortgages, and soft home prices,” wrote BMO senior economist Sal Guatieri. “But how much higher?”

He notes that the “vast majority” of Canadian mortgage holders have continued to faithfully make their mortgage payments, even if that has meant reducing discretionary spending and, in some cases, negotiating a longer amortization with their lenders to lower monthly payments.

“This has helped stabilize aggregate mortgage service costs as a share of income, albeit near record highs,” Guatieri says.

But despite recent easing from the Bank of Canada and a decline in fixed-rate mortgages, a still-rising unemployment rate is expected to drive delinquencies higher in the near term.

In June, the national unemployment rate rose two percentage points to 6.4%, translating into a total of 1.4 million unemployed individuals. According to projections by Oxford Economics, the unemployment rate could top out at 7.5% by the end of the year, though BMO sees it peaking at around 7%.

“With the rise in unemployment and mortgage resets, we expect some upward drift in arrears,” according to Guatieri.

In addition to a rising unemployment rate, a record number of mortgage renewals at significantly higher rates in the coming years is also expected to pose a challenge for many borrowers.

According to the Bank of Canada, the median payment on a maturing loan could rise by 34% by the end of 2027.

“For some borrowers, payments will modestly exceed stress-tested levels,” Guatieri says. “Others, however, will benefit from fixed rates that are now less than the qualifying rate, which for many was 5.25%.”

The mortgage stress test ensures borrowers can manage payments even if rates rise. It requires qualifying at the higher of the Minimum Qualifying Rate, currently 5.25%, or their contracted mortgage rate plus 2%. This helps prevent defaults by ensuring borrowers have a financial cushion.

How this cycle compares historically

But even with a sustained rise in the arrears rate from current levels, it would take quite a bit of momentum to approach the long-term average rate of 0.40%.

BMO forecasts mortgage arrears to peak at 0.34% by mid-2025 before settling back at 0.28% in the medium term.

Canada’s arrears rate would have been significantly higher due to the pandemic-driven spike in the unemployment rate, which reached 13.7% in May 2020—the highest rate recorded since comparable data became available in 1976—had it not been for income-support programs, aggressive rate cuts, and the rapid economic recovery, BMO adds.

The resilience of the Canadian housing market has also contributed positively. Home prices have remained robust, providing homeowners with equity that can be leveraged if necessary, thus providing a cushion that has acted as a safeguard against a significant rise in arrears.

However, BMO acknowledges there are upside risks to its forecasts. For example, a rise to 9% in the national unemployment rate due to a weaker economy would cause the arrears rate to “modestly surpass” its long-run mean.

And if home prices were to fall another 14%, “the arrears rate would peak just below the long-run mean,” Guatieri says.

But the more likely scenario is that falling interest rates will support a “modest recovery” in the economy and house prices and “limit the strain of mortgage resets, he adds. “The mortgage stress test, introduced in 2016, should pass its first big test.”

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Last modified: July 30, 2024