Canadians who locked into 5-year fixed mortgages during the historically low interest rates of the COVID era are currently enjoying a period of financial stability. But for many, this calm could be shattered in the coming years as their terms end and they face the reality of a much steeper interest rate environment.

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Rapid Rate Hikes in 2022

The Bank of Canada embarked on an aggressive tightening cycle in 2022 to combat inflation that had reached decades-high levels. This cycle saw a rapid succession of interest rate hikes, marking the most significant tightening period in Canada's history. By early 2023, the policy interest rate had reached 5%, a level not seen since 2001.

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5-Year Fixed Mortgages

While these rising interest rates have impacted variable rate mortgages and new fixed-rate mortgages, those with existing 5-year fixed mortgages are, for now, shielded from the immediate impact. The beauty of a fixed-rate mortgage is that the interest rate remains constant for the entire term, providing predictability and stability in monthly payments. This acts as a buffer against short-term interest rate fluctuations.

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However, this protection is temporary. Once the fixed term expires, typically after 5 years, homeowners will need to renew their mortgage at the prevailing market rate. If interest rates have climbed during this period, as they have in Canada, homeowners could face a significant increase in their monthly payments upon renewal.

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The Low Rate Legacy of the COVID Era

Data from March 2024 shows that the typical 5-year mortgage holder in Canada was still paying a remarkably low interest rate of just 2.97%. This seemingly low national average can be attributed to the surge in Canadians who locked into 5-year mortgages during the ultra-low interest rate environment of the COVID era. With such a large portion of mortgages locked in at these low rates, the overall average has been significantly skewed downwards.

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The Coming Wave of Renewals

The current low national average for 5-year fixed mortgages is on borrowed time. The sheer volume of mortgages originated during the low-interest-rate period has masked the true impact of recent rate hikes. However, this is about to change dramatically.

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A significant portion of these 5-year mortgages are approaching their renewal dates. As these terms expire and homeowners refinance, the impact of higher interest rates will be undeniable. Here's a breakdown of projected renewals:

• 2023: An estimated 10% of 5-year mortgages renewed.
• 2024: The number of renewals is projected to double to 20%.
• 2025: A further increase is expected, with 30% of all 5-year mortgages projected to renew.

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The Mortgage Cliff

This surge in renewals, coupled with the current market rate hovering around 5%, is expected to cause a significant rise in the average outstanding 5-year mortgage rate over the next two years. This sharp increase could be likened to a "mortgage cliff" for many homeowners.

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Planning for the Future

For Canadians with 5-year fixed mortgages approaching their renewal dates, it's crucial to start planning for the potential increase in monthly payments. Here are some steps to consider:

• Review Your Budget: Assess your current financial situation and determine how much additional monthly payment you can comfortably manage.
• Stress Test Your Finances:  Many lenders use a stress test that qualifies you at a higher interest rate (typically the contract rate + 2%) to ensure you can afford your mortgage even if rates rise. Consider performing a similar stress test on your own finances to see how higher rates would impact your budget.
• Explore Options:  Talk to your mortgage lender about different renewal options and explore ways to potentially mitigate the impact of higher rates, such as extending the amortization period or increasing the down payment.

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Conclusion

The historically low interest rates enjoyed by many Canadians with 5-year fixed mortgages are coming to an end. The next few years will see a significant wave of renewals, pushing the national average interest rate upwards. By being proactive and planning for this potential increase, homeowners can navigate this financial shift more smoothly and ensure their homeownership journey remains stable.