The Canadian Mortgage Variable Rate Boom Is Now A Bust 

Canadian real estate’s fling with variable rate mortgages is pretty much dead. Bank of Canada (BoC) data shows originations fell sharply, with variable rates representing just a tiny share in January. Variable rates went from the majority of mortgages to an unusually small share, in just one year. 

Canadian Mortgage Borrowing Is Unusually Slow

Canadian mortgage originations ground to halt according to the latest data. The volume of mortgage origination funds fell 41.0% (-$14.4 billion) to just $20.7 billion in January. It was the lowest monthly dollar volume since February 2019, and the weakest January since 2015. It’s really, really slow.  

Variable Rate Loans Are A Small Share of Borrowing Once Again 

Mortgage originations with variable rates represented just a tiny share of those funds. In January 2022, most (56.9%) credit issued was attached to a variable interest rate. One year later, it represented just 16.7% of January’s volume.  

Share of Canadian Mortgage Originations With Variable Rates

Mortgage originations with variable rates as a share of total new mortgage credit.

Source: Bank of Canada; Better Dwelling.

The uncharacteristic boom and bust of the variable market is highlighted in the above chart. The share of new lending issued rarely passed 20%, but we see a sudden surge before collapsing. What the heck happened? This all boils down to short-term thinking regarding payments and cost.  

Canadian Mortgage Borrowers Were Incentivized By Inefficiency

Most borrowing prior to the variable rate boom had been 5-year fixed rate mortgages. These are traditionally the most popular mortgage option, with its rate determined by the Government of Canada (GoC) 5-year bond yield. Variable rate mortgages aren’t determined by bond prices, but the Bank of Canada (BoC) overnight rate. Typically in healthy markets, both would rise and fall with relatively small delays. 

That’s not what happened in 2021, when the GoC 5-year bond yield climbed but the BoC didn’t hike rates. Surging credit growth and elevated inflation had the market pricing in higher interest rates. The BoC misread on the issue resulted in the overnight rate holding… even as inflation popped well out of target by April 2021. Simply stated, the 5-year bond reflected the market’s opinion, whereas the overnight rate represented the BoC’s opinion. This resulted in the surge seen in the chart, as borrowers looked to tap the central bank’s inefficiency. 

Note the plunge in the share of variable rate mortgages beginning in March 2022. That was the month when the overnight rate began to climb, and it became apparent the gap would close. Fewer people wanted to get caught with escalating payments, and the horror stories in the news didn’t help. Canadians returned to fixed rate mortgages, and falling 5-year yields starting in November 2022 helped provide a little more incentive to borrowers. 

Now that the 5-year bond is falling and fixed-term rates are getting cut, the variable market isn’t all that appealing. While the market is pricing in cuts later this year, borrowers are waiting to see those cuts materialize. Inflation at 3x the target rate is lower than the peak, but still significant market froth for the overnight rate to handle.