How high variable-rate mortgages cripple homeowners, hobble housing market

Two years ago, when Canada kept interest rates low to spur on the pandemic-crippled economy, Sarah and Graeme Dueck sold their townhome and bought a house in Langley, one big enough for a basement suite they could rent out at a subsidized price to help vulnerable youth.

Over the last year, the Duecks’ mortgage payments nearly doubled, increasing by $2,600 a month.

“My husband and I were living in a little townhouse and we felt like we really wanted to do something about the housing affordability crisis. So we thought: Let’s buy a house where we can have a subsidized rental for somebody who really needs it. That was our motivation for actually taking on a really big mortgage,” said Sarah Dueck, who rents the suite at a below-market rate to a youth who was previously in foster care.

The couple had budgeted to be able to handle a modest rise in interest rates. In fact, consumers must show they can afford to pay a higher “qualifying rate” before being approved for a mortgage.

“But the rates rose so quickly that we had to scramble a little bit to rearrange our budget. The first thing that we did was we stopped all of our investments,” said Dueck, an engineer. “Everything we had, we started putting into our mortgage.”

She and her husband, a teacher, cancelled their Christmas vacation. They are bringing in extra money by renting out rooms in the main part of the house to two university students. They are managing, though, and do not need to sell their home to stay afloat.

“We’re hoping that things will come down in the next year. I think we’re planning on riding out the storm,” she said.

The Duecks are far from alone.

When borrowing rates fell to record lows in recent years, about three out of every five Canadian mortgage holders chose variable rates, up from the typical average of about one-third, said Brendon Ogmundson, the chief economist with the B.C. Real Estate Association.

Variable mortgages, which go up or down depending on the prime interest rate, became more attractive because they were far cheaper than fixed-rates, for which the interest rate and the monthly payment remain the same for the term of the agreement, which is often five years.

But as the Bank of Canada lending benchmark shot up last year to combat historical high levels of inflation, variable rate mortgages suddenly became far more expensive than the locked-in fixed rates.

“This 4.5 per cent increase in one year is unprecedented,” said Pang “This is totally new territory and it caught everyone off guard.”

Real estate sales boomed in the early years of the pandemic. Many people, who were suddenly working remotely while their kids were doing school from the kitchen table, used access to low lending rates to buy a bigger home with, perhaps, room for an office and a big backyard.

“If we all had a crystal ball and knew what happened last year, of course no one would have taken variable. Everyone would have taken fixed,” said Pang, a mortgage consultant for 13 years.

This reflection is also personal. The monthly payments for the variable-rate mortgage on their Surrey house have risen $2,000 for Pang and his wife, who have two school-aged boys.

“We’ve had major lifestyle changes,” said Pang. “It’s been really tough.”

To cover the increased monthly costs, the family has cut back on the boys’ extracurricular activities, reduced eating out, shops at less-expensive grocery stores and doesn’t buy pricey foods like steak, postponed a trip to Europe, cashed in investments, and paused any “rainy day” savings.

“It’s raining right now. We just need to survive today,” said Pang, who also has two rental suites in his basement.

“There’s no shame in having to take a second job. We need to do what we need to do to survive for the next little bit. There will be better days but we just have to get through the next year or so.”

His clients had different ways to pay these unexpectedly higher monthly fees. Car purchases were delayed. Those with jobs in the trades took overtime shifts.

He and his wife Lida, who have a variable mortgage on their Langley house and had their monthly payments increase by hundreds of dollars, are also making financial sacrifices to make ends meet. They, too, are renting out their basement.

There were several elements that made variable-rate mortgages more attractive than fixed-rate mortgages, Francis said. For example, until last year, they typically had a lower qualifying rate, which gave first-time buyers a better chance to get into B.C.’s expensive real estate market.

And the penalties are far lower with variable than with fixed mortgages if the homeowner wants to break the agreement to buy a new property. This is particularly helpful for consumers who might want to upgrade starter homes before the five-year fixed term is up because their families are growing.

There are two types of variable mortgages.

The first is adjustable, which means payments go up at the same pace as the prime interest rate hikes.

The other more popular option is static, which means there is a set payment each month but how much goes toward the principal will fluctuate based on how much money is left over after paying the interest rates. But, a “trigger clause” is hit when the static monthly payment isn’t high enough to cover rising interest costs, and then the borrower has to start paying more or stretch out the amortization of the mortgage.

Reaching that point had seemed impossible, Pang said, until last year, when it kicked in for many people.

“No one ever paid attention to (the trigger clause) because it was ‘when pigs fly’,” he said. “Well, pigs flew last year.”

Two of Pang’s clients with variable mortgages, married teachers raising three young children in Langley, had the monthly payments on their Langley townhouse rise by $1,000 a month.

The husband told Postmedia they can no longer save money for a detached home or put money in RESPs for their kids’ education. “That’s all taken a back seat now,” the husband said. But the couple is staying resilient and hoping interest rates fall soon.

The higher borrowing rates cut home sales by 50 per cent over the last year. And Ogmundson expects home sales to remain relatively flat in the short-term, as those with fixed mortgages will also have higher payments when they have to renew.

Although the outlook for the economy remains uncertain over the next year, he said there are no signs yet that British Columbians with mortgages are in such dire financial straits that they are forced to sell their homes: There has not been a flood of new listings hitting the market, defaults on mortgages are low, and the labour market remains strong — meaning people are still working to pay these higher bills.

“It is a bit surprising how strong households have been and how little impact there’s been on financial vulnerability,” Ogmundson said.

One explanation, he said, is that people saved money during the early years of the pandemic, when they were travelling less and going out less, and perhaps those nest eggs are helping with the higher mortgage payments. That solution is not, of course, sustainable for the long term.

Both Francis and Pang, the mortgage consultants, do see hope on the horizon for mortgage holders. Inflation numbers are going down, fixed rates are decreasing, and the Bank of Canada has not hiked interest rates in recent months.

So, right now, both men say people renewing mortgages or new buyers may want to consider short, fixed-term agreements, perhaps for two- or three-year terms. By then, variable rates may be lower and more attractive again.

Although the prime rate is not expected to start going down until early 2024, they recommend most variable-rate mortgage holders stick with the plan, even though they know — personally and professionally — it has been hard.

“If you are able to weather the storm right now,” Francis said, “just hang on a little bit longer, because I do see some relief coming.”