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.