Banks search for ways to help vulnerable variable-rate borrowers avoid default on their loans

Canadian banks are trying to help homeowners who are facing issues with the sharp interest rate increase. The banks offer extending mortgage amortizations and sometimes adding unpaid amounts to the borrower’s loan principal. While such ways can help you avoid mortgage default in the short term, they may have serious consequences in the future.

Following a fast increase of its key lending rate from almost zero at the beginning of 2022 to 3.75% right now, the central bank noted that approximately 50% of borrowers with variable-rate, fixed-payment mortgages have already reached the so-called trigger point – a moment when usual monthly payments cover only the interest. Meanwhile, the principal remains unpaid. The BoC says almost 13% of all Canadian mortgages are influenced by the rate hikes.

Under federal rules, mortgages must be amortizing. It means borrowers are obliged to be repaying the principal. However, lenders have three options when a trigger point is reached: they can increase monthly payments, demand a lump-sum pre-payment, or let borrowers enter negative or reverse amortization for a period determined by banking authorities and mortgage insurers.

Negative or reverse amortization happens when mortgage payments aren’t enough to cover interests. In this case, the excess amount is added to the principal, and such actions can leave homeowners with a bigger outstanding balance when they renew.

According to certain industry specialists, it is “reasonable” to conclude that reverse amortization is also happening, while we don’t have official data on that right now. It may intensify risks for the lender and borrower as the loan balance is going up. This can be especially worrying amid a house prices decline.