Canada’s banking watchdog has issued a stark warning about a looming financial challenge for homeowners with mortgages taken out during the pandemic. With interest rates having surged from near-zero levels, many borrowers will face significant increases in their mortgage payments when they renew their loans.
The Office of the Superintendent of Financial Institutions (OSFI) highlighted this "payment shock" as a critical risk in its latest financial system risk outlook released on Wednesday. According to OSFI, 76% of outstanding residential mortgages as of February will need renewal by the end of 2026. Particularly concerning are the 15% of mortgages with variable rates but fixed payments. These loans are becoming "negatively amortizing," meaning that borrowers' regular payments no longer cover the full interest costs, causing their principal balances to increase.
Borrowers facing negative amortization will eventually have to make lump-sum payments or accept much higher monthly payments. OSFI warned that this could lead to more residential mortgage loans falling into arrears or defaults.
High home prices, elevated interest rates, and inflation continue to strain Canadian households. Although the labor market remains relatively strong, any weakness could significantly alter the risk landscape, the report noted.
The Bank of Canada’s benchmark overnight lending rate has been at 5% since last July, the highest in over 20 years. This rate affects many Canadians with mortgages tied to the central-bank rate, prolonging their financial difficulties as long as rates remain elevated.
Peter Routledge, the superintendent of financial institutions, compared the issue of variable-rate mortgages with fixed payments to a “mouse in the snake” — a significant problem that banks are slowly digesting but which still poses substantial risks.
“The good news is that banks and Canadians are managing that problem early, and part of the reason we’ve been vocal about it is to prompt a bit of early action,” Routledge said in a recent interview.
The OSFI report also raised concerns about security risks from hostile foreign actors and issues related to wholesale credit and liquidity. To address these threats, the regulator plans to establish a new group focused on ensuring financial institutions mitigate risks to national security, including fraud and money laundering.
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