Welcome to Mortgage Rundown, a quick take on Canada’s home financing landscape from mortgage strategist Robert McLister.
There’s been a fuss in real estate circles about the mortgage stress test damaging the housing market.
Earlier this month, the Toronto Regional Real Estate Board (TRREB) questioned whether the current mortgage stress test “remains applicable.” It comes after data from the Canadian Real Estate Association showed a 22-per-cent nosedive in median Greater Toronto home values in just five months.
“Is it reasonable to test home buyers at two percentage points above the current elevated rates,” TREBB propounded, “or should a more flexible test be applied that follows the interest rate cycle?”
Our banking regulator, which devised the mortgage stress test, recently responded. Peter Routledge, head of the Office of the Superintendent of Financial Institutions, stated in a speech on Sept. 8: “Let me reassure those of you who oppose a loosening of underwriting standards that OSFI will not do that.”
OSFI would likely contend that the stress test is doing exactly what it was designed to do, ensure new mortgagors can withstand higher rates and economic uncertainty as borrowing costs mount.
If, for example, OSFI only required borrowers to prove they can afford a one percentage point increase in rates – instead of the current two percentage points – homeowners would be able to qualify for larger mortgages, giving them even less financial breathing room. That could lead to higher mortgage defaults if rates and inflation exceeded all expectations.
OSFI contends this would add risk to the banking system. Albeit, some would argue the risk is insignificant in cases where borrowers lock in a mortgage for five full years. After all, they’d pay down their mortgage significantly in that time, on top of getting pay raises and – in more typical markets – price appreciation.
Indeed, if the stress test were ever eased some day, regulators might be more prone to do so on five-year fixed terms or longer.
OSFI says it is constantly evaluating its mortgage underwriting policies to monitor the “risks of pro-cyclicality.”
Pro-cyclicality occurs when a policy measure amplifies natural fluctuations in the financial system, according to OSFI spokesperson Elizabeth Roach. OSFI is concerned about policy measures that could amplify a market downturn or stress scenario.
Technically, any stress test that makes it harder to qualify for a mortgage, thus removing demand amid a sell-off, is pro-cyclical. It’s a question of how much more home prices fall because of it. The more prices fall, the less equity there is to protect financial institutions from borrower defaults.
For now, the regulator isn’t ready to do anything about it. So, for those who want an easier mortgage stress test, you’re going to have to use a non-federally regulated lender – or wait.
Wait for what?
If you get an uninsured mortgage at a federally regulated lender today’s lowest possible stress test rate is 6.69 per cent. That equals 4.69 per cent – the lowest nationally available rate – plus two percentage points, OSFI’s stress test buffer.
But once an end is in sight to Bank of Canada rate hikes, more investors will start buying bonds. That’ll push bond yields lower (bond prices and yields move inversely), which typically pulls fixed mortgage rates lower.
Not long after, when the Bank of Canada starts easing monetary policy again, that’ll pull down mortgage rates even further.
So we just have to wait.
As for how long, Andrew Hunter, senior U.S. economist at Capital Economics, said in a report on Wednesday, “We still expect a sharp fall in inflation to eventually persuade officials to start cutting rates in the second half of next year.”
The bond market is pricing in a Bank of Canada rate cut by December, 2023. That might be wishful thinking. The point is, Canada’s economy cannot withstand significantly higher rates for prolonged periods. Consumers are simply too leveraged. They’re up to three times more rate sensitive than the last time inflation was this high – in the late 1970s and early ‘80s.
But rest assured, high stress test rates won’t be with us forever. But they’ll be with us long enough to hammer home prices a bit more, and that’s something to be expected in a down cycle.
For those with liquidity, a long-term investment horizon and a penchant for real estate, embrace the future real estate opportunity this bear market creates.
Mortgage rates stay level
Financing costs have plateaued in the past few weeks. Lenders are now waiting and watching for the bond market’s reaction to next Tuesday’s potentially blockbuster Canadian inflation report and next Wednesday’s U.S. rate announcement.
As this goes to press, we’re just about a quarter-point below a 14-year high in the five-year bond yield. Yields are typically a lead indicator of fixed-rate mortgage pricing so a hot inflation report from Statistics Canada or a hawkish U.S. Federal Reserve next week could easily take fixed rates higher.
The converse is not necessarily true.
Our Big Six banks, which control most of Canada’s mortgage market, are biased to keep rates higher. In fact, at least one big bank is lifting rates again this week. Amid unrelenting inflation, falling home prices, higher loan-loss provisions, impending recession, high rates for guaranteed investment certificates and elevated credit risk, funding costs may have to drop more than normal to result in lower fixed rates at the big banks.
The message is, don’t expect much better rates near-term. And if you’re out there shopping for a home, get that pre-approval lickety-split.
Rates shown in the accompanying table are as of Wednesday from providers that advertise rates online and lend in at least nine provinces. Insured rates apply to those buying with less than a 20 per cent down payment, or those switching a pre-existing insured mortgage to a new lender. Uninsured rates apply to refinances and purchases over $1-million and may include applicable lender rate premiums. For providers whose rates vary by province, their highest rate is shown.
This & That
Increasing credit card delinquencies, fewer people paying their balance in full, surging revolving debt usage and rising unemployment are a precursor to mortgage defaults, says Rebecca Oakes, vice-president of advanced analytics at Equifax Canada. She predicts defaults will rise noticeably by next year, but nothing like the early 1980s when more than one in 100 borrowers were in mortgage arrears for 90 days or more.