What Effect Are The Mortgage Stress Tests Having On Canadian Home Buyers?

It was about this time last year when the race-was-on!

Buy a house NOW! was the narrative.

One year ago, a buyer with 20% or more down payment could purchase a home and qualify for their Mortgage, based on market interest rates.  This means, their home affordability was calculated based on their ability to service their Mortgage payment at market interest rates.

January 1st 2018 a new stress-test would take effect.

Let’s be clear on something and go further back in time …

Stress Test: Wave #1

November 2016 saw the first wave of Mortgage stress testing come into effect.  This stress test was to be applied to all home buyers with LESS THAN 20% down payment.

If you’re a buyer with less than 20% down payment today, this Mortgage stress test “rule” has been in effect for two years now.

The high-ratio (less than 20% down payment) stress test interest rate is called the “Mortgage Qualifying Rate” or MQR.  The MQR is based on the Big 6 Banks 5-year posted interest rate in Canada.

[Yes, the banks could whimsically raise or lower this interest rate.  However, no data as of today supports this conspiracy theory ;-)]

Stress Test: Wave #2

January 1st, 2018 saw the new B-20 Guidelines come into effect.  This targeted Mortgage applicants with 20% or greater down payment.

This stress test is not based on the Mortgage Qualifying Rate (MQR).  This stress test is based on a qualifying interest rate 2% higher than market interest rates.

At the time the rule came into effect, the B-20 stress test rate and the MQR were about the same.  However, with Mortgage interest rates increasing, and primed for further upward pressure, the B-20 qualifying rate could start to be very high.

Here’s What This “Stress Test” Means For You:

1. Your Mortgage qualifying ratios factor the cost of owning a home (Mortgage payment, property tax, heat and 1/2 condo fees (if applicable), combined with other debt).
2. The Mortgage payment portion, as an input into your Mortgage qualifying ratios, is based on your Mortgage amount being paid at the applicable Qualifying Rate.
3. Today the MQR is 5.34%.  The B-20 stress test is about 5.89%.

One’s ability to purchase a home is based on one’s ability to make Mortgage payments AS-IF your Mortgage interest rate was at the higher percentage rate.

Why?

Because our Central Bankers want to protect the financial stability of Canada’s housing market.  Really, they are protecting us from ourselves. #bigbrother.

Today’s market interest rates are bottoming out from HISTORIC lows.  It’s possible that Canadians, renewing their Mortgage in 5 years (or even today) will be renewing their Mortgage at higher interest rates (potentially significantly higher interest rates).

What Do Our Central Bankers Think?

I can’t exactly say the powers that be “thought through” the B-20 stress test guideline.  To be clear, I am in agreement with the rule.  I get it.

What’s missing for me is a longer term plan or vision for this rule and the direction of Mortgage qualifying in Canada.  I mean, interest rates are going to rise and eventually plateau.  I’m not sure it’s fair, or good for our housing market, to continue stress testing buyers based on rates 2% higher than market FOREVER.

Canada inherits about 2/3 of U.S bond prices just because.  With the U.S economy currently on fire (albeit signs of slowing, a looming debt crisis, and the reversal of quantitative easing), their 30 year bond could be continue to climb another 0.50% – 0.75% in 2019.

The financial vulnerability of skyrocketing property values in two major centres (Toronto & Vancouver) is one major area of focus our Central Bankers are actively trying to cool or softly land.

These Mortgage qualifying guidelines, bluntly said or not, are targeting these two markets.  The question is, could these guidelines and the reaction of a changing market, in-and-of-itself, be the reason for vulnerability exposure?

Here is a chart from the Bank of Canada showing the percentage of Insured and Conventional Mortgages with more than 450% loan-to-income ratio.  This group of high loan-to-income borrowers are the highest risk to our financial system.  They represent the most vulnerable group of home borrowers in Canada.

Conclusion:

Honestly, at this point, the results of this chart is the effect Canadian Mortgage lending policy makers wanted to see.

However, Real Estate, and a large part of Canada’s construction industry, contribute to Canada’s National income (our GDP).  And numbers are down.  In fact, new home construction, for the three months of June, July and August, represent the lowest consecutive home construction numbers (as a percentage of GDP) since 2009!

Here’s how this relates back to Calgary home prices …

What this really is doing is placing down pressure on home buyer demand.  Buyers can afford a less expensive home.  The new Mortgage qualifying regime is also coming into effect the same time fixed and variable interest rates are increase.  Without piling on here …Calgary’s unemployment rate is north of 8% with inflation adjusted wages flat (for a decade).

Solution time …

Here’s how to help yourself qualify for a home:

1.  Keep consumer debt low.
   1. Credit cards.
   2. Car loans.
   3. Personal loans.
2. Have pristine credit.
   1. Payments on time.
   2. Low balances relative to limit.
   3. Maintain existing credit open, do not cancel.
3. Have your own down payment.
   1. Save the minimum 5%.
   2. Have money left over as a “short-fall”.

Connect with me to help plan your eventual home purchase.  You’ll want to have a plan to protect yourself from increasing interest rates, adjust your Mortgage for inflation and save money (banks make less).

Call or email me directly.

Talk soon,

Chad Moore