Bank of Canada Rate Hikes Pose Threat to Variable-Rate Borrowers

Variable-rate borrowers may face significant challenges if the Bank of Canada raises interest rates. According to Robert McLister, a mortgage strategist and interest rate analyst, a rate-hike cycle can become much more unpleasant for those with variable-rate mortgages.

The biggest concern is that a payment jumping 20 to 40 per cent can be difficult to manage, especially if the borrower has a smaller monthly cushion. This is why it's essential to have backup liquidity in the form of assets to justify pushing debt limits.

Another issue is piling up debt, which can make it challenging for borrowers to handle increased payments. People often overbuy not just their homes but also other items on credit, such as cars and furniture, without considering the long-term implications.

McLister notes that income stalls can also exacerbate problems for variable-rate borrowers. Layoffs, separation, or a decrease in disposable earnings can make it difficult to afford increased payments.

However, McLister argues that fixed payment variable rate mortgages (FPVRMs) are not the solution either. He states that while FPVRMs may provide some protection against payment spikes, they ultimately quit amortizing when rates climb too high.

Rather than opting for FPVRMs or ARMs, borrowers should consider variable-rate mortgages (VRMs). VRMs hold payments steady unless rates climb past the point where they cover all interest. In such cases, most lenders raise payments to at least cover interest.