In a recent report released by the Parliamentary Budget Office on financial vulnerability and household indebtedness, calculations on the effect of higher interest rates on loan service costs were provided for Canadian consumers. The office reports that an increase from 2.9 per cent to 4.8 per cent, spread from the first quarter of 2017 to the last quarter of 2021, will be applied on interest rates for mortgages. Non-mortgage debt, on the other hand, is expected to rise from 5.4 per cent to 7.6 per cent over the same course of time.
This increase in the current interest rates, if not mitigated, will result in a very challenging scenario for consumers, as well as impact the overall economy of the country, as seen from the point of view of a mortgage broker.
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A Possible Scenario, But…
This sharp increase in the interest rates is just one of the possible scenarios predicted by the PBO to be highly likely to occur. But still, this is just an assumption and there is no real guarantee that it will occur. Other probable scenarios will result to varying impact estimates.
The PBO forecast seems to be similar to the ones released by major banks during the past years wherein an increase in interest between 1.5 points to 2 for the next couple of years was predicted. The prediction has been proven wrong, but the forecast continues to follow the pattern.
This current forecast also looks like a mean reversion, according to expert mortgage brokers because the PBO is not able to provide a believable argument to its recent prediction on the increase on the bond rate’s decade benchmark. Another report from the office stated a revised upward outlook on interest rates which seem to reflect the higher-than-anticipated rates from the United States. No hard facts are provided that support the high increase in the interest rates.
Possible Mitigating Factors
Service costs for debts, as calculated by the PBO, includes the ¾ obligated mortgage payments, required fees on the amortization contracts, and the monthly minimum payments applicable to other debt types.
In reality, a high percentage of mortgage borrowers are paying more than what is required. PBO assumes that borrowers are obliged to settle $76 billion but according to a mortgage report, borrowers are paying $105 billion, or a positive difference of almost $30 billion. There is room for adjustment on the borrowers’ side if PBO’s forecast becomes a reality.
Also, principals of mortgages are being settled at a rapid rate because of the current low interest rates. In fact, more than half of the principal repayment is covered by the borrower’s initial payment. This means that in five years, around 15 per cent of the principal would have already been paid. In the event of an increase in the interest rates, there’s still room for payment rescheduling.
Although it may be true that interest rates will increase in the future, facts don’t support PBO’s numbers. There is no way to forecast the actual amount but the resilience of the borrowers’ financial situation is enough to mitigate the impact.