As we mentioned in our Weekly Update for July 28th 2017, the Office of the Superintendent of Financial Institutions (OSFI) released a set of proposals that would serve to tighten up the conventional mortgage market. The objective of these proposals is to protect would-be home buyers from over-extending themselves during our current low-rate environment against further rate increases; additionally, the measures look to protect banks from creditor default risk.
On a more basic level, the proposed measures have been put forth to protect the economy overall. Canadians owed an average of $1.67 per $1 of disposable income, according to a debt-to-income report released by Statistics Canada in December of 2016. The Bank of Canada, as well as many of the “Big 5” banks, has been vocal about household debt levels. The Bank of Canada has also raised concern over inflated house prices in major Canadian markets such as Toronto, Vancouver, and recently including Victoria and Hamilton. Rising rates and an uptick in unemployment could lead to increased mortgage defaults.
How Would It Work?
The counteractive proposal for uninsured, conventional mortgages would require potential buyers to qualify for their mortgage using a new stress-test qualifying interest rate. Where the high-ratio stress-test rate is simply the Bank of Canada’s 5-year fixed rate (recently raised to 4.84%), the conventional stress-test rate would be the street rate offered by the lender plus 200 basis-points (2%).
So, let’s say you have a mortgage rate offered by your bank or credit union for 2.85%. When qualifying, your bank/credit union would use the stress-test rate of 2.85% + 2.00% = 4.85%. The logic is simple: if you can qualify – and afford – your payments at a rate of 4.85% in this case, then surely, you’ll be able to absorb an interest rate hike of 25bps (as we’ve experienced twice now in the last 3 months).
Of course, it’s important to remember that the borrower would only be exposed to the increased rate when their current mortgage term expires.
What’s the Bottom Line?
Analysts believe that if enacted, prospective borrowers would lose about 20% of their purchasing power. For instance, if without the stress-test, a borrower could qualify for a $1 Million mortgage, when using the stress-test, the same borrower would only qualify for an $800K mortgage.
If enacted, this proposal would look to cool the overheated Canadian real estate markets with a more precise, surgical approach, rather than the more broad-based interest rate hikes (which affect the economy overall due to cost of borrowing, the effect on the Canadian dollar, etc).