Home ownership in the core 35-44 age bracket fell a few percentage points since 1999.Christopher Katsarov/The Globe and Mail
Welcome to Mortgage Rundown, a quick take on Canada’s home financing landscape from mortgage strategist Robert McLister.
Fixed mortgage rates are about 500 basis points – five percentage points – cheaper at the end of 2021 than they were at the beginning of 2000.
Other things equal, that would have made it far easier to carry a new mortgage. As fate would have it, though, a higher percentage of borrowers’ income goes to mortgages today than it did in 1999, the Bank of Canada says.
And not only did lower rates not improve Canadian’s debt-to-income ratio, rock-bottom rates did little to help young Canadians afford a new home.
Over all, the percentage of Canadians who own a home edged somewhat higher in the past two decades, but it was mostly skewed to older adults. Home ownership in the core 35-44 age bracket actually fell a few percentage points since 1999.
And now we all face the prospect of higher rates, as early as March, according to current market forecasts. Rate hikes make mortgage payments less affordable, relative to rent, and make it harder to qualify for financing. This effect persists until other fundamentals, such as rising incomes or home supply, offset the impact.
Forecasting the rate effect
Higher rates should weigh on home prices in 2022, especially if and when average mortgage rates exceed 3.25 per cent. Typical five-year fixed rates are around 2.69 per cent today.
That 3.25-per-cent threshold is when the government’s “stress test” buffer will likely kick in for a meaningful percentage of borrowers.
The stress test requires bank borrowers to prove they can afford a mortgage payment based on the greater of: a) a 5.25-per-cent “floor” rate, or b) their actual mortgage rate plus a two-percentage-point “buffer.”
If average five-year fixed rates shot up one percentage point from today, five-year fixed borrowers would be stress-tested at 5.69 per cent or so, instead of 5.25 per cent currently.
By my calculation, It would take almost 4 per cent more income, or a 4-per-cent reduction in home prices, to offset this more strenuous stress test.
The more that average mortgage rates rise above 3.25 per cent, the tougher that mortgage approvals could become, particularly for the two out of three purchasers who buy the home they can afford, according to CMHC’s 2021 Mortgage Consumer Survey.
Variable shift
The unintuitive reality is, home ownership is now less accessible to young home buyers despite record-low rates.
And as rates start climbing, less financially endowed borrowers will grow increasingly desperate. Many who would have never considered a floating-rate mortgage will choose a variable rate, simply to pass the stress test.
The above-mentioned stress test “buffer” is the reason.
Take today’s typical average five-year fixed rate of 2.69 per cent. It only need to jump 57 basis points, to 3.26 per cent, before the stress test buffer begins making mortgage qualification tougher. At that point, five-year fixed borrowers would automatically be stress-tested at rates above today’s 5.25-per-cent floor.
For variable rate borrowers, who now enjoy rates of 1.45 per cent or less, it’s a different tale. For them, it would take a run-up in rates of more than 180 basis points before the stress test got more strenuous. That’s assuming Canada’s bank regulator doesn’t change the stress test rate before its next scheduled review in December, 2022.
Long story short, there may come a time where more indebted borrowers are forced to choose a variable-rate to get approved, or choose a more expensive non-federally regulated lender.
This won’t be a big deal – unless rates surge far more than 180 basis points. And for that to happen, the Bank of Canada would have to be drastically underestimating future inflation.
Rates in the accompanying table are as of Dec. 30 from providers that lend in at least nine provinces and advertise rates on their websites. Insured rates apply to those buying with a down payment of less than 20 per cent, or those switching a pre-existing insured mortgage to a new lender. Uninsured rates apply to refinances and purchases of more than $1-million and may include applicable lender rate premiums.
Mortgage rates were sleepy the past few weeks
Despite a 30-basis-point dive in five-year government bond yields since Nov. 23, average fixed and variable mortgage rates actually rose slightly. That’s nothing extraordinary given lenders rarely compete aggressively in the last few weeks of the year.
Unless five-year yields buck market expectations and slide another 25 basis points or more, chances are that mortgage rates won’t improve much from here, potentially for several quarters, maybe even years.
Robert McLister is an interest rate analyst, mortgage strategist and columnist. You can follow him on Twitter at @RobMcLister.
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Robert McLister