Everyone in Canada is trying to determine why real estate prices have suddenly increased. However, the data from the Bank of Canada (BoC) points to a more direct explanation: witchcraft. In reality, it’s the return of easy access to debt and the resulting increase in leverage. The decrease in new mortgage interest rates in February provided leverage comparable to that seen in March’s increase in home prices.
Interest rates for Canadian mortgage borrowers are dropping
Lenders in Canada are benefiting from a flood of new home loans with reduced interest rates. In February, rates on new loans were 5.53%, down from 5.63 in January. The current rate is 3.14 percentage points more than it was this time last year, and it is higher than January. That’s more than in the previous month but less than in the same period last year. This is a crucial reminder as we continue to analyze the data.
There Is Minimal Effect At This Point On Canada's Mortgage Stress Test
At present levels of mortgage debt in Canada, changes in interest rates are felt quite keenly. Canadian banking watchdog OSFI has a stress test for mortgages called Guideline B-20. Borrowers will be able to pay either 5.25% interest (the maximum allowed by the Guideline) or the contract rate plus 2 percentage points. It performs an excellent job of limiting credit up to the 5.25% line, but thereafter leverage starts swinging wildly. The amount people are able to borrow responds extremely instantly to changes in the interest rate.
It's important to note that not all mortgage lenders are subject to the stress test
Non-stress-tested lenders have their own methods of reducing exposure to risk. If the interest rate is over a certain threshold, then the quoted rate is used for the computation. This morning, I opened my go-to mortgage app to find that helpful hint waiting for me. There’s no harm in reminding folks that they have more leverage than they realize, right?
So, are you any closer to understanding the stress test now? Imagine you were able to negotiate a 6.00% interest rate on your mortgage (by the way, your mortgage broker is lousy) and an 8.00% stress test rate. Now let’s say your pal decides to borrow a month from now and locks in a mortgage rate of 5.75 percent. They’ve also gotten an additional 0.25 percentage points off their stress test rate. It didn’t matter much when mortgage points were 2 and the minimal stress test rate was 4.75%. The floor was put in place, reducing the impact on everyone other than those with big pockets.
The Effects of Interest Rates and Borrowing in Canada
You need to know that leverage is related to housing prices in order to appreciate the significance of this. This is common knowledge, as evidenced by a recent explanation from a former BoC Deputy Governor on how low interest rates encouraged borrowers to spend more money on the same home. Interest savings due to lowering rates were formerly widely accepted. Over the past 30 years, historically, low-interest rates have not benefited purchasers, but given sellers more bargaining power. For thirty years, prices rose to compensate for the shortfall, until someone eventually did the math.
To borrow money, or use leverage, is to squander the fruits of your future effort right now. A certain way to drive up housing costs is to provide incentives for individuals to buy what they need and then allow them to borrow more and more of their future earnings to pay for it. This is Canada’s housing catastrophe, and it was made this way on purpose.
Recent Home Price Growth in Canada Is Reflected in Falling Mortgage Rates
Take another look at the uninsured mortgage rate. Although a 0.12-point decline in February may not seem like much, it would increase a buyer’s purchasing power by about 1.2%. That’s an additional $11,500 in debt for a couple making $200,000 annually. It’s extremely close to the $12,300 gain that the median house saw in March. It is quite likely that the whole growth was due to the use of leverage.
For the return of low-cost leverage, the Bank of Canada should just ease off on quantitative tightening. Government bond liquidity has not been tightened, thus falling fixed mortgage rates continue to stimulate demand.