If interest rates remain higher for longer amid stubborn inflation, experts warn that an increasing number of homeowners will be at risk of a trigger rate that would raise monthly mortgage payments, for some to devastating levels.

Rob McLister, a mortgage specialist, said in an email to Yahoo Finance Canada, "Mortgage default risks should be contained from payment reset startup rate adjustments, unless inflation is further contained."

"The issue is overstated because we don't know what will happen next." Variable-rate mortgages usually have fixed monthly payments, with less and less of those payments going toward principal as rates rise.

With rising interest rates, some homeowners may see their payments reach the startup rate, the point at which the interest portion due is higher than the principal repayment itself.

Once that happens, the lender can offer the homeowner a number of options including increasing the total monthly payment to cover at least the full interest portion, extending the amortization period, or demanding a lump sum payment to reduce the principal loan amount.

While Canada's largest banks have stated that most mortgage clients can afford the increase in their monthly premiums, McLister said some homeowners may find themselves in financial trouble.

He said if the Bank of Canada raises the policy rate by an additional one percentage point, it "will wipe out a larger but modest percentage of household budgets."

He added that the additional two-percentage-point increase would be "catastrophic" and lead to a more severe recession. The biggest risk, according to McLister, is if the market underestimates inflation and the Bank of Canada needs to move the key interest rate materially above 4.25 percent.

Currently, overnight swap data shows markets expect the overnight rate to reach 4 percent by the end of the year, up from just 0.25 percent in March.

A significant minority of variable-rate mortgages will have negative monthly cash flow due to a rise of more than 400 basis points. We are likely to see the government intervene at that point with some kind of relief plan.

"Perhaps regulators will formalize an industry-wide policy allowing consumption extensions, for example," he said. Gradual problem "It really depends on where prices go. And if someone has a view that rates will be steady at these levels over the next several years, the higher rates in 2023, 2024, 2025, that will be a bigger risk," Mike Rizvanovich, an analyst at Kitchener Brought Woods, told Yahoo Finance Canada in a phone interview.

Royal Bank of Canada said in its third-quarter earnings call in August that the number of mortgages at their trigger rate is expected to reach 80,000 with the "next two interest rate hikes." "The average increase is about $200.

Neil McLellan, head of RBC's personal and commercial banking group on the call at that time, said we only – less than 0.5 percent of clients who we think will even need a call. In the conference call held by Toronto Dominion Bank in August with analysts, the bank said that any variable-rate borrower off track from their mortgage amortization schedule would need to adjust their payments at renewal to get back to the original amortization date.

"The one thing people sometimes get wrong about Canadian banks is that they monopolize the few where they come to you and kick you out of your home if you miss a mortgage payment. It's not really like that. They will work with you and explore different ways just not to force you into bankruptcy because it's not really in their interest to acquire a bunch of homes and try to sell them at potential prices."

But the ability to pay monthly payments on time is a key factor in whether banks will work with the borrower. "They will look at your ability to bear that debt. And really, it's individuals who probably have a very tough position where obviously the bank will monitor that and recommend, you know, maybe you have to sell your home," he said. Sticky renewal shock Rizvanovich says higher mortgage rates will become a more urgent issue over time due to the housing boom during the pandemic when rates were very low. Using Canadian Statistics data, Bank of Montreal previously said 60 percent of new mortgages as of December 2021 had a variable rate, evidence of how popular they were as homebuyers wanted to take advantage of extremely low rates.

"If you're talking about sticky renewal shock, a lot of that will come in 2024 and 2025, just looking at the typical term people take in the mortgage, and all the high activity we saw in the latter part of 2020 and for, Rizvanovich said, "most of them, almost was in 2021.

So they won't see this pain until two to three years from now." Banks vs. alternative lenders vs. private money Canada's largest banks control four out of five mortgages, or about 1.6 million mortgage loans, according to McLister.

He estimates that at least 350,000 clients could have their trigger rate activated if the policy interest rate reaches four percent as markets expect. But banks' mortgage books have historically shown resilience during economic pressures since banks dominate the traditional lending market. Historically, the mortgage book has never been an issue related to direct credit losses. Now, not to say that in recessions there are no problems around credit losses and people facing bankruptcies, but losses are usually not directly related to the mortgage portfolio.

Rizvanovich said, "usually other unsecured things, like credit card debt, car loans." He added that the main risk of interest rates rising for longer will be damage to consumer spending and how that affects the local economy. He said alternative lenders, like Home Group or the parent company of Equitable Bank, deal with many non-prime borrowers, but those lenders are still regulated, which limits risks in their mortgage books. For homebuyers who don't qualify for a loan from regulated lenders, they may resort to the riskier private lending market.

Private sector lenders consist of small companies or wealthy individuals lending their own money to finance mortgages and operate outside regulated financial institutions.

Loans are usually short-term, carry a much higher interest rate, and can have high loan-to-value ratios.

There is also much less transparency in this market because it is unregulated. This is generally where the bulk of the risk will be.

If you think of Canadian banks, the big six banks, they don't do non-prime lending in mortgages. I mean, they just don't do it at all. Rizvanovich said: "They are very strict on how they calculate your ability to repay the debt."

Editing: Yusra Bamtraf