Our government could have made it tougher today to get a mortgage, but chose not to. Is that something to celebrate or did policy makers just drop the ball?
In case you missed it, here’s what happened on Friday.
The Office of the Superintendent of Financial Institutions (OSFI) and Department of Finance announced they’re leaving the minimum mortgage qualifying rate (a.k.a. “stress test” rate) as is. That means you must still prove you can afford a payment at the greater rate of 5.25 per cent or your actual interest rate plus 2 per cent to get a bank mortgage.
The stress test’s key purpose is to “assess a borrower’s ability to continue making payments in adverse conditions,” OSFI assistant superintendent Ben Gully said on a media call Friday. And as rates rise materially, the stress test is designed to get tougher, automatically, thanks to that 2-per-cent buffer.
The banking regulator said it considered the economic outlook, household indebtedness, home-price imbalances and borrower performance when announcing its decision Friday. Credit risks have risen “only modestly” since the last stress test decision in June, Mr. Gully said.
That’s curious, however, given Canadian housing imbalances have arguably worsened since then:
· Home prices are up another 4.8 per cent;
· Debt ratios keep rising;
· The Bank of Canada’s favoured loan-to-income metric is surging to records;
· Investor speculation is at long-term highs;
· Resale housing inventory (supply), as measured by the Canadian Real Estate Association, just hit a record low.
Apart from an improving jobs market, it’s not a stretch to expect imbalances will intensify in the first half of 2022. Omicron could keep real estate listings and mortgage rates low for a while. In fact, five-year government bond yields – which lead fixed mortgage rates – have fallen 45 basis points in the past four weeks, largely on virus concerns. (There are 100 basis points in a percentage point.)
Next year will see a planned 411,000 new immigrants looking for homes and a continued inability of housing supply to catch up. Critics of Friday’s decision argue that the more home prices detach from long-term fundamentals, the harder they’ll fall when real estate listings revert to above average levels.
And lest we forget, rate hikes can be kryptonite for home prices. The prime rate and the national average home price have more than a 75-per-cent negative correlation.
That coincides with economists, like Scotiabank Economics, predicting the Bank of Canada will have to boost rates up to eight times to bring inflation back to its 2 per cent target, with 100-plus basis points of hikes coming in the next 12 months.
The threat level isn’t high enough for regulators (today).
“Indebtedness creates risk for the Canadian financial system,” Mr. Gully said Friday, and that heightens sensitivity to rate increases.
But the supply and demand imbalance, while leading Canadians to “resort to more leverage when buying a home,” is “a longer-term prudential risk,” Mr. Gully said.
For the foreseeable future, OSFI suggests the financial system will be stable enough to leave the stress test as is. Mortgage arrears are at record lows, most homeowners have ample equity to get them through hard times and the government isn’t going to let defaults run wild, as it proved with pandemic mortgage deferrals.
“OSFI’s purpose is to ensure prudent lending and financial stability, not to manage the market,” Paul Taylor, CEO of Mortgage Professionals Canada, said in an e-mail.
A tougher stress test “would only marginally improve the health of a current portfolio,” he says. “Loss of employment is the real trigger to default. … In today’s COVID world, a 25- or 50-basis-point increase to an already very stringent test wouldn’t do much to assist but would hurt more aspiring middle-class families.”
Canada’s Finance Minister, Chrystia Freeland, seems to largely agree. “Addressing housing affordability is a priority,” she said in a statement Friday, “especially for middle-class Canadians hoping to buy their first home.”
That middle class, particularly first-time buyers who account for more than half of all home sales recently, are also voters. Our leaders don’t want to portray themselves as the big, bad government making it unnecessarily harder for you to qualify for a mortgage. Nor, allege housing bears, do they want to upset the Jenga stack that is housing with unnecessary restrictions.
Ultimately, the regulators’ latest decision will itself be tested – if interest rates surge, there’s another economic crisis and/or housing inventories shoot back above normal. But that test may not happen in 2022, and regulators have promised to adjust the stress test before the next scheduled announcement one year from now if conditions warrant.
If you’re out there mortgage shopping, there’s no need to stress about the stress test, at least from a qualifying standpoint. If you want to get around it, all you have to do is:
· Visit a credit union that doesn’t impose the federal stress test;
· Have 35-per-cent to 50-per-cent equity – in which cases some banks will allow you to have higher ratios of debt to income; or
· Choose a non-prime lender that allows for higher debt ratios.
The availability of these loopholes, as well as home buyers taking on “worrying” amounts of indebtedness (the Bank of Canada’s words), are why many will argue regulators should have made the stress test at least nominally more stringent. Maybe they could have changed the minimum qualifying rate back to its 2019 level of 5.34 per cent.
We’ll see whether OSFI actually waits all the way until next December to adjust it again.
Robert McLister is an interest rate analyst, mortgage planner and contributing writer for The Globe and Mail. You can follow him on Twitter at @RobMcLister.