Mortgage refinances have fallen off a cliff. They’re down by 32 per cent, according to the latest data from the Canada Mortgage and Housing Corporation (CMHC).
The question is why?
It’s not like people don’t need to refinance. On the contrary, a record number of Canadians are up to their earlobes in debt. On top of that, many are dealing with mortgage payments that have rocketed 40-plus per cent.
McLister: This week’s lowest fixed and variable mortgage rates in Canada
Throngs of homeowners desperately need to restructure their debt. But there are three key reasons why they can’t. Here they are, and here’s what to do about it if you’re in this boat.
Reason #1: Tumbling home values
Until recently, median prices in most parts of Canada were down at least 20 per cent from the 2022 peak, to ballpark data from the Canadian Real Estate Association (CREA).
That’s a problem for many, as you need at least 20 per cent equity to refinance at mainstream lenders.
Assume, for example, that you took out a $400,000 mortgage in December, 2021, on a $500,000 home, amortized at 30 years with a 2.69-per-cent rate. A 20-per-cent drop in the value of the home would put that mortgage at more than 96 per cent loan-to-value, making refinancing impossible.
That’s why Canada’s latest upswing in prices is critical for many homeowners – particularly those blocked from refinancing because of their property value.
By the way, if preliminary median price data from the Greater Toronto, Vancouver and Calgary areas are indicative, price appreciation could continue in May, thus boosting refinance volumes, all else being equal.
Reason #2: Soaring rates
Higher borrowing costs eliminate refinance demand from those looking to lower their interest costs and prevent borrowers from reducing their total payments.
To illustrate, suppose you have enough equity and qualifications to refinance and want to combine $75,000 of debt at 13 per cent with your existing $300,000 mortgage. Meanwhile, your mortgage rate is 2.69 per cent, half of what you’d pay today. In this case, breaking that mortgage to refinance results in a wash in total monthly payments – i.e., the payment savings on the high-interest debt is offset by the payment increase in the mortgage.
Add in fees and prepayment penalties, and there are few cases where debt consolidation refinances make sense.
Two exceptions for qualifying borrowers are when a lender allows “blends” or separate-portion mortgages. Blends effectively let you keep your existing low rate while the lender charges you current rates on any new money you borrow. Your old and new rates are combined into one new weighted average rate, which accounts for the balance of each portion.
Pro tip: If you want refinance flexibility, ensure your lender doesn’t charge you hidden penalties to blend. Some do, and unwitting borrowers often find out too late. The time to ask about blend policies is before you commit to a lender.
The other exception is separate-portion mortgages, which are common if you have a what is known as a readvanceable mortgage or combined loan plan. In these cases, you can borrow more money without affecting your existing rate. The lender simply tacks on a new portion to your existing borrowing.
Reason #3: The stress test
Fifteen months ago, a qualified borrower with a $100,000 income and no other debt could afford a $479,000 mortgage, give or take.
Today, that same borrower can afford only about $410,000.
That’s because rising rates have made the government’s stress test more challenging. The stress test forces borrowers to prove they can afford a rate that’s the greater of 5.25 per cent or two percentage points above their actual rate.
As recently as 2018, these same borrowers used to qualify at major banks and access the best available discounted rates. And before that, in 2016, refinances were default-insured, allowing borrowers even more savings and choice relative to big banks. Regulators changed all that, however, leaving the Big Six banks with a virtual stranglehold on refinance funding for prime mortgages.
In any event, in their quest to reduce risk in the banking system, regulators have pushed a record number of these stress test flunkers into the arms of more risk-tolerant lenders.
Mortgage investment corporations (MIC) which offer high-cost, higher-risk loans, have been growing at four times the rate of big banks, CMHC says. MIC’s overall share of new mortgages (10.47 per cent) tripled from the first half of last year to the second half.
At these sorts of non-prime lenders, borrowers pay rates and fees that are a minimum of one to three percentage points higher than those of mainstream lenders.
That’s a key point because higher borrowing costs have contributed to a record number of Canadians having high ratios of monthly debt to income. One in six households with mortgages now see more than 50 per cent of their gross income going to servicing monthly obligations. Take taxes out of the remainder, and it doesn’t leave them with much.
For these reasons, the rate- and regulatory-driven shift to non-prime lending could boost the risk of default for thousands of borrowers. These folks are also kept in debt longer – which is not ideal when you’re trying to lower risk in the financial system and prevent a future retirement crisis.
Time will tell, but regulators have likely underestimated these side effects of their stress test and refinance insurance policies. Meanwhile, subprime lenders are celebrating their business windfall.
Markets price in another dose of tough rate medicine
“Higher for longer” is again the buzzphrase in Canada’s rate market. So much for the mini-U.S. banking crisis, which drove rates lower for all of two months.
Now we’re dealing with a U.S. debt ceiling mess and persistently disappointing inflation indicators, not the least of which is stubbornly low unemployment. Both those factors have been driving rates higher.
As a result, this past week saw the lowest nationally available:
- Two-year fixed rates jump 20 bps
- Three-year insured rate jump 20 bps
- Four-year insured rate jump 15 bps
- Five-year uninsured rate jump 20 bps
(Basis points, or bps, are one-100th of a percentage point.)
Another 25-basis-point hike from the Bank of Canada or U.S. Federal Reserve would reinforce that they’re not about to gamble with bringing inflation back down to their 2-per-cent target.
One more hike by both central banks, which the market deems more likely than not, would drive another nail in inflation’s coffin. That could prove valuable insurance. The last thing Canada can afford is inflation – and inflation expectations – reigniting. That’s a nightmare scenario for central bankers, and it would considerably delay the first rate cut.
If we do get another hike, look for bond yields – which drive fixed mortgage rates – to drop again before long. The more the market believes that central banks are serious about inflation, the sooner rates will fall to their long-run average.
Rates are as of May 25, 2023, 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.
Robert McLister is an interest rate analyst, mortgage strategist and editor of MortgageLogic.news. You can follow him on Twitter at @RobMcLister.