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The Bank of Canada is raising concern about the impact of higher interest rates on renters while acknowledging that, even as most households appear to be managing increased debt servicing costs, there are still many mortgage holders who will face large payment increases when they renew over the next two and a half years.

The adjustment to higher interest rates “continues to present risks to financial stability,” Bank of Canada governor Tiff Macklem said Thursday as the bank released its annual report on stresses across the financial system.

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The report also flagged “stretched” valuations of some financial assets, a sharp rise in the use of leverage in the non-bank financial sector that includes pension funds and hedge funds, and risks from exposure to commercial real estate where weaker demand has pushed the national office vacancy rate up to around 20 per cent.

Senior deputy governor Carolyn Rogers, who has previously raised concerns about renters, said the data compiled suggests there is stress in these households.

“After hitting historical lows during the pandemic the share of households without a mortgage that are behind on credit card and auto loan payments has come back up to — or surpassed — typical levels,” she said. “And over the past year, the share of borrowers without a mortgage who carry a credit card balance of at least 80 per cent of their credit limit has continued to climb.”

Since the Bank of Canada began to hike interest rates in March 2022, payments have increased for about half of all outstanding mortgages. Over the next two and half years, a big share of these mortgages will renew and these borrowers will face large payment increases.

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“Over the coming years, more borrowers will face pressure as they refinance existing mortgages at higher rates,” the report said. “Higher debt-servicing costs reduce a household’s financial flexibility, making them more financially vulnerable if their income declines or they face an unexpected material expense.”

The report showed that the median increase in monthly mortgage payments will be more than 20 per cent at renewal in 2025 and more than 30 per in 2026, compared with origination.

“The financial pressure will increase most for households that took out a mortgage in 2021 and early 2022 when house prices were close to their peak and mortgage rates were very low,” the report said. These buyers generally took on large mortgages relative to their incomes and have seen very little increase — and potentially a decrease — in their home equity.

By the end of 2023, more than a third of new mortgages had a debt-service ratio greater than 25 per cent, double the share in 2019.

The Financial Stability Report said large banks with healthy capital cushions are handling the stresses in the mortgage market so far, but some smaller lenders have already seen a sharp uptick in credit arrears.

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“Increased provisions for loan losses are impacting profitability but also enhancing banks’ resilience,” the report said, adding that funding for banks remains stable through deposits and wholesale capital markets, though costs have increased.

The report said small and medium-sized lenders are likely seeing more mortgages in arrears because their borrowers tend to have higher risk profiles. In addition, with typically shorter terms, nearly all these borrowers have renewed. In contrast, about half of the mortgages at large banks have yet to renew.

The Financial Stability Report suggested that with conservative wage increases, most borrowers should be able to manage, and that some are increasing savings and adjusting payments, including making lump-sum contributions. A bigger shock to the financial system, including the banks, would be felt with a hit to wages, such as rising unemployment.

• Email: bshecter@postmedia.com

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