It just became slightly tougher to qualify for a mortgage, as Canada’s central bank just upped the rate used to stress test new borrowers.
The Bank of Canada hiked its conventional five-year fixed mortgage rate on Thursday, May 10th, from 5.14 to 5.34 per cent. Now, mortgage applicants who are paying less than 20 per cent down on their home purchase must prove they can qualify at this rate in order to receive home financing. Borrowers who are making larger down payments must now either qualify at this rate, or their contract rate plus 2 per cent – whichever is higher.
Related Read: What is the Guideline B-20 Stress Test?
What is the BoC’s Conventional 5-Year Mortgage Rate?
While not the actual rate used by consumer lenders, the BoC’s conventional 5-year mortgage rate reflects the current standard interest rate for five-year fixed mortgages. It is determined by averaging the five-year fixed posted rates offered by each of Canada’s Big Six lenders – and they’ve been on a hiking spree as of late.
TD started the upward trend, increasing its rate 45 basis points to 5.59 per cent in April – an abnormally large hike that the bank attributed to the “competitive landscape, cost of lending, and mortgage risks”. And, because the big banks tend to move in lock-step, the remaining five followed suit, with increases between 5 – 20 basis points for their five-year fixed posted products.
Why Are Fixed Mortgage Rates Rising?
Fixed mortgage rates are on the rise because the yields on government bonds have also been on an upward trend. These bonds are used as a funding method by the banks; when yields rise, that signals lower investor demand, and so they increase their fixed borrowing products to fill the gap.
Bond yields have been steadily ticking higher since June 2017, and are currently at 2.2 per cent – the highest in six years. For perspective, in 2015 – 2016, when fixed rates were at record lows, yields trended below 1 per cent.
While this may sound odd, this upward movement is actually in response to a strengthening economy, and more specifically, the Bank of Canada hiking its Overnight Lending Rate (it has done so three times since July 2017, to the current 1.25 per cent), as well as hikes from its U.S. counterpart, the Federal Reserve. Bond investors aren’t big fans of tighter monetary policy – when rates rise, it immediately devalues the return they can expect to receive on their investments (also called a coupon). For this reason, rate hikes lead to bond sell offs, which in turn lead to higher yields, and, ultimately, higher fixed mortgage rates.
How Should Mortgage Borrowers Prepare for Higher Rates?
With both variable and fixed mortgage rates on the rise, along with the qualifying criteria for stress tests, it’s more important than ever to build a financial buffer into your shelter costs.
While the 20-basis-point increase to qualifying criteria isn’t enough to make or break a mortgage application, the stress test – which came into effect on January 1st – in general reduces the average buyer’s affordability by roughly 20 per cent. For a new borrower, this could mean downsizing home buying expectations, either purchasing a home at a lower price point, or house hunting in a more affordable market.
For existing fixed-rate borrowers, lenders hiking their rates won’t have an immediate impact – but they may need to contend with a higher interest rate environment when they come up for renewal (those refinancing their mortgages, or switching to a new lender upon renewal will indeed be stress tested).
And, while recent fixed-rate increases aren’t applicable to variable-rate borrowers, the fact that the Bank of Canada is on an upward trend – at least one more rate hike is expected before 2018 is through – means monthly payments are likely to rise in the medium-term.