This was an interesting statement by RBC Economics on Monday:
"Even if households are paying down their equity over the next five years, if interest rates were to [climb] by one to two percentage points [over that period], when it comes time to renew, many households who are buying now will ultimately see their mortgage payments increase."
The truth is, virtually any interest rate increase at all (let alone one to two percentage points) will leave you paying more at renewal, all else equal. Many don't realize that.
Here’s an example that makes the point.
In this sample scenario, a 5-year fixed borrower renews their original mortgage (Mortgage 1) into a new term (Mortgage 2). Despite a mere 10-basis-point increase in her mortgage rate, and despite paying down her mortgage balance for years, she experiences higher payments. Why?
The reason is simple: Lenders keep your amortization the same when you renew.
Whether your payments rise or fall after renewing depends on the rate and amortization.
So even though you pay interest on a much smaller balance after renewal, your new payments will be higher because the rate is higher and the amortization is now five years less.
Of course, you could always refinance to increase your amortization, thus lowering your payments. But then you'd need to qualify for that refinance because it's considered a brand new mortgage. Getting approved for a new mortgage at prime mortgage rates is not always possible for people who need to lower their payments.
Rates are based on a home value of $400,000
With decades of down-trending fixed rates, Canadians have seldom faced higher renewal rates. But in the next year or so, that could change. If you got a mortgage in 2016 or 2017, then unless you refinance, your payments could possibly increase on your next renewal.
You’ll want to plan for that by "stress testing" your mortgage using at least one percentage-point-higher rates. You can do that by:
- Going to a mortgage calculator
- Entering your expected remaining balance at maturity
- Entering a one percentage-point-higher rate than you have now
- Entering your remaining amortization at renewal (e.g., if you started with a 25-year amortization and are renewing after five years, your remaining amortization is 20 years)