What do Canadians do when interest rates are high?

For many Canadians, a mortgage is the largest financial commitment they will ever undertake.

The sharp rise in interest rates after 2022 reminded borrowers that mortgage costs can change significantly when mortgages renew. In Canada, most borrowers renew their mortgages every few years. As a result, changes in interest-rates could be passed on to households more quickly in Canada compared to some other countries. Currently, shorter-terms mortgages have more favorable rates than longer-term ones.

Recent experience highlighted an important feature of our country’s mortgage system: households bear much of the risk when interest rates change. While this can increase exposure when rates rise, it also allows borrowers to benefit more quickly when rates fall.

In recent years, some people have turned to variable-rate mortgages, while others have preferred shorter fixed-rate mortgage terms. Visit our quarterly data snapshot to see the trend. A mortgage term is the period during which the mortgage contract and interest rate are fixed before renewal. These choices may appear technical, but they matter when economic conditions shift.

Moreover, CMHC’s Mortgage Consumer Survey suggests that Canadian mortgage consumers who renewed a mortgage were more likely to say they experienced increased financial pressure due to changes in interest rates (35%). Results also show that 25% of mortgage consumers have regrets about some of the characteristics of the mortgage they chose. Prior to the inflation surge of 2022, decades of low interest rates and steady economic growth often made this risk seem modest. Recent inflation volatility has reminded Canadians that mortgage-renewal risk is real.

If the economy is less stable in the years ahead, mortgage-term choices may matter more than many borrowers once assumed.

Canadians are moving to short-term mortgages

Before the recent rise in interest rates, most mortgages were standard 5-year terms. Many of these mortgages have since come up for renewal at higher interest rates than borrowers originally took out.

As a result, variable-rate mortgages gained market share since 2022. Borrowers also shifted away from fixed-rate mortgages with terms of 5 years or longer toward shorter fixed-rate terms. This shift was especially pronounced among uninsured borrowers (see Panel A). Uninsured mortgages tend to have shorter terms (see Panel B).

These changes in mortgage-product choice affect more than borrowing costs. They shape households’ exposure to future interest-rate changes and influence how interest-rate risk is distributed across the mortgage system.

Mortgage choices shift over time, but these shifts don't mean borrowers are making poor decisions. Choosing a mortgage means weighing many unknowns at once, including:

• future interest rates
• inflation
• income risk
• refinancing opportunities, and
• household mobility

Even with expert advice, households must make decisions without knowing how economic conditions will evolve (Campbell and Cocco, Quarterly Journal of Economics, 2003).¹

International systems allocate interest‑rate risk differently through funding structures

Recent interest-rate volatility has renewed attention to how mortgage contract structures affect households when rates change, as noted by the International Monetary Fund (PDF) and the Bank for International Settlements (PDF). Mortgage systems differ in who bears the risk when interest rates change.

Different countries have different mortgage systems suited to their own circumstance. Like Canada, countries such as Australia, New Zealand and the United Kingdom rely more on short-term or variable mortgages. By contrast, borrowers in the United States and much of continental Europe typically use long-term fixed-rate mortgages, supported by funding systems that allow lenders to manage interest-rate risk differently. Long-term mortgages as in the U.S. place the primary focus of housing risk within the U.S. financial system rather than with households. The 2008 housing crisis showed that this could prove fragile and spill over to households.

Interest-rate risks are borne by households in Canada

Households make mortgage choices to manage borrowing costs and interest-rate uncertainty. But these choices occur within a broader system that allocates risk among households, lenders, investors and taxpayers.

Countries allocate interest-rate risk in different ways, and no mortgage system eliminates that risk. Canada's mortgage system places a large share of the risk from interest-rate changes on households.

For much of the period from the mid-1990s to 2020, the risk of higher mortgage costs at renewal may have appeared remote. Recent inflation and interest-rate volatility have shown that this approach carries risks.

As households increasingly choose shorter mortgage terms, they also take on greater exposure to future interest-rate changes. Ultimately, mortgage term choices are more than financing decisions. They can affect a household's financial stability for years to come.

¹ Campbell and Cocco, Quarterly Journal of Economics (2003)