We’ve had back-to-back changes
recently in the mortgage world – one direct, one indirect. The benchmark rate
used to qualify will change downwards starting April 6, 2020, and the Bank of
Canada (BoC) just cut its key lending rate from 1.75% to 1.25%.
Two years ago, the stress test was
introduced as a safeguard against rising interest rates, to make sure
homebuyers would still be able to make their mortgage payments if their rate
increased. To qualify for a mortgage, buyers need to qualify at the greater of
2% higher than the contract rate or the Bank of Canada’s average 5-year rate,
which today is 5.19%.
Earlier this month, Minister of
Finance, Bill Morneau, announced changes to the benchmark rate used to
determine the qualifying rate for insured mortgages – mortgages with less than
20% down payment. This change will come into effect on April 6, 2020.
There has been mixed response from the financial community
about this change. For some, the new qualifying rate will make it more
affordable; for others, it won’t make much of a difference, especially in
hot-market areas, where prices are rising quickly.
Then, on Wednesday, March 4, 2020, the BoC cut its key lending rate by 50
basis points, from 1.75% to 1.25%, which had an almost immediate effect on
lines of credit and variable-rate mortgages -- banks dropped their prime rate
from 3.95% to 3.45%.
This means that borrowing costs for mortgages, auto loans and
other lines of credit are set to head lower. Consider a $400,000 mortgage on a 2.95% variable rate.
The mortgage rate would shift to 2.45%, and mean about $100 per month in
savings.
Why is
this happening?
The interest
rate drop comes on the heels of the US Federal Reserve’s decision to lower its
rate by .50 points due to the global economic challenge posed by the
uncertainty of the coronavirus that will likely affect domestic spending. The
BoC’s rate cut of the same percentage took many by surprise – it was expected
that rate would drop a quarter of a percentage.
There were also other yellow alerts prior to the coronavirus
– a drop in global equity markets and in oil prices, created uncertainty in the
financial markets. It wasn’t a stretch to think that the same drop in
confidence would hit consumers as well. The BoC does not want to jeopardize
domestic growth.
With regard to the
stress test, there has been pushback from some economists and housing experts
who say that the new stress test will just further fuel the housing market.
Here’s what we know about the stress
test:
- Currently, the stress test for insured mortgages is 5.19%
(the minimum rate at which homebuyers must qualify, no matter the actual
contract rate.)
- The new stress test, if it was in place today, would be approximately
4.89%.
- The Big Banks will no longer determine the stress test rate.
This is good news. Banks have been hesitant to cut their-five-year posted rates
(which the stress test is based on). This has made it more challenging for
borrowers to qualify for a mortgage.
- Borrower’s will have slightly more purchasing power
Here’s what we don’t know:
- How it will affect the average buyer. This will depend on a
variety of factors, including the location of the property being purchased. In
smaller markets, the new benchmark could help affordability for some buyers – in
larger markets such as Vancouver or Toronto, it may have little effect.
- If it will affect home prices. More consumers qualifying for
a mortgage may increase demand and put upward pressure on prices – there is
still a shortage of properties available for sale.
- The new benchmark calculation, as stated, is more flexible.
If interest rates continue to fall, then, in many cases, buying power would
also increase.
As always, time will tell how all this will play out and
there is talk that the BoC will cut the rate at least once more this year.
What
does this mean for fixed versus variable-rate mortgages?
Fixed rates are priced on the bond market, which have
fallen quite dramatically since January, so it’s likely that fixed rates will
continue to move lower. Now, with the
BoC rate cut, and the banks following suit by dropping their prime rate,
variable-rate mortgages will also drop.
Many factors go into deciding whether to choose a
fixed or variable mortgage, and it’s a topic to discuss with your mortgage
professional.
For now, these changes could be good news for homebuyers.