We all know that the housing market in Canada, and particularly Toronto and Vancouver, had some impressive years of price appreciation. It’s no secret that the biggest contributor to housing price increases has been ultra-low interest rates. After the global economic crisis in 2008, all the central banks started monetary easing policies that has resulted in low rates.
In 2015, Canada surprised everyone again when they dropped their overnight rate two more times to 0.5%. The main reason for these drops were to support the fledging oil prices and support business growth. The problem however, was the economy was stuck and these new low rates still weren’t producing signs of business growth. However, for the housing sector is was huge boost because suddenly, affordability for a mortgage improved. Everyone could afford the payments on more expensive homes. Real estate investors could easily cover their costs through the expected rental income.
In response to the heated housing market, many people felt it was necessary to cool it down. Every day the newspaper had “bubble” in it somewhere. The natural method to cool it down would be to raise rates but, again, they couldn’t do this easily because the economy was still stuck in neutral.
Levers to pull
Enter the screw tightening process. The housing market has seen a plethora of levers to take the air out:
- BC’s 15% tax on foreign buyers (worked for about 6 months)
- Ontario government’s announced 16-point plan (more fluff than anything)
- Department of Finance – new tougher rule changes
- Increase in mortgage insurance rates and capital requirements
- More rule changes by the Federal Regulator of Financial Institutions (OSFI).
All of this, coupled with the Bank of Canada’s hammer lever - two recent rate increases of the Overnight rate, has produced a nice soft landing for housing. Today, there isn’t much talk about a bubble. I think I heard a collective “phew” across the country.
Bank of Canada Qualifying Rate
So, we know the Bank of Canada has an “Overnight Rate” but what is the is “Qualifying Rate”? It has different names including: Qualifying rate, Benchmark rate, Stress Test Rate, etc. The Bank of Canada calls it the “Conventional mortgage – 5-year” rate on their website but I’ve never heard any lender call it that.
The Qualifying Rate was originally designed to make people qualify for variable rates at a higher rate so that if rates increased during the term, they could still meet their debt servicing obligations. It’s certainly a noble idea.
At the time of writing this, the Qualifying Rate is sitting at 4.84% (click here). How did they choose this rate? The funny thing is, this number is not some well-constructed purposeful number. It’s simply an average of the 5 year posted rates of the six largest banks. Does this seem a little odd? Where is the thoughtfulness? Where is the independence?
Have you seen how much deliberation the Bank of Canada and Mr. Polloz puts into setting the overnight rate? They choose their words very carefully and take their job seriously. It seems a little careless that they are simply content with an average posted rate of Banks.
What is the this posted rate anyhow? The major banks all publish a “posted rate” for each term that is about 1.5-2.0% higher than the actual best rates that are available. While its technically possible, I haven’t seen anyone get duped into signing for posted rate on their mortgage. I’ve worked at major bank in the mortgage head office and the only purpose for a posted rate is for their penalty calculations. Banks use the difference between posted and the actual mortgage rate to help calculate a penalty amount, should you break early. The wider delta at longer terms produce a much larger IRD penalty versus a fair method. If you haven’t read about this trap – read more.
Okay, so we’ve established that the Bank of Canada, is flippantly providing an official rate that all institutions must use to qualify a few mortgages. A few mortgages? Try:
- ALL mortgages that are less than 5 years
- ALL variable rate mortgages
- soon to be ALL insured and conventional mortgages that falls under OSFI of any term
The Bank of Canada Qualifying Rate was introduced originally to protect variable rate mortgage holders against rate shock. It provided a buffer against an inability to meet their payment if rates rose quickly. The Department of Finance is concerned about large loan losses on the books of our big banks and bank stability.
Since it was first introduced, the Qualifying Rate has become more widely utilized as an additional lever to slow down the housing market. Proposed changes by OSFI’s B-20 regulations will increase the use of the qualifying rate to all mortgage holders. It will have an even greater role of importance in who is approved for a mortgage and who will not!
The Qualifying Rate can be used to slow down or speed up the mortgage and housing market. We shouldn’t allow this rate to be determined by corporate business banks with mandates to shareholder profit. The Bank of Canada needs to be more proactive and take ownership of setting this rate with thoughtful rationale. As a concerned Canadian, doesn’t this seem like a reasonable request?
About the Author:
Ian Mucignat, CFA, is an independent mortgage agent at TMG The Mortgage Group. He graduated from Wilfrid Laurier University with a Bachelor of Business Administration, minoring in Economics and is a CFA Charterholder. Ian has worked in the mortgage industry since 2000 at lenders, banks, and brokerages. If you are purchasing, renewing, or refinancing your mortgage don’t hesitate to contact Ian directly for a free consultation.