Canadian Mortgages Under Scrutiny As Stress Test Kicks In
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Canadian Mortgages Under Scrutiny As Stress Test Kicks In


Written By: Jim Adair
Thursday, March 22, 2018

Canadas new mortgage stress test requires anyone who is getting a mortgage from a federally regulated financial institution to qualify at two percentage points above the Bank of Canada posted rate or the actual contracted rate. The new rule was implemented because of concern over rising household debt and overheated real estate markets in Southern Ontario and B.C.

It has focused attention on Canadian mortgages and prompted suggestions for how mortgage rules could be tweaked to better serve both home buyers and lenders.

Mortgage Brokers Canada, in a discussion paper authored by Will Dunning and Samuel Duncan, says the much-referenced "posted mortgage rate" from the Bank of Canada "misrepresents actual conditions and is potentially misinforming participants and policy makers.

"Publication of the date may be doing more harm than good," say the authors.

The paper argues that actual contracted mortgage rates are far less than the posted rates. Mortgage Brokers Canada tracked the difference over 10 years from 2006 to 2016, finding that the average gap was 1.38 points in the fall of 2006, rising to 1.94 points by 2016.

"If posted rates provided an indication of what actual rates might be in future, then the data would be useful to borrowers, so that they could calculate how their payments might change in future and they could assess their ability to afford their future costs," say the authors. "But, there is no evidence that actual contracted mortgage rates do tend to move towards the posted rates."

The stress test anticipates that in five years when most mortgages come due, interest rates will be two per cent higher. "However, at current interest rates, in five years approximately 15 per cent of principal will have been repaid, and more importantly income will have increased likely by 10 per cent," says the Mortgage Brokers Canada paper. "As designed now, the stress tests take neither of these events into consideration.

"By using the two-point increment today, the stress test is unduly restrictive and unnecessarily impairs the housing market and the broader economy."

Dunning and Duncan argue that using an interest rate that is 0.75 points higher than the actual mortgage interest rate would accomplish the stress goal and take repayment of principal and rising income into consideration.

"While this may be more complicated to communicate to the consumer, it is a market-based measure that can protect consumers in the wake of rising rates, while not unduly restricting mortgage financing to borrowers who are able to afford their initial obligation as well as their likely future obligations," say the authors.

Another discussion paper by Michael Feldman of the C.D. Howe Institute says the government should allow longer amortization rates for residential mortgages. He says it would give consumers more choice, while increasing competition in the mortgage market and removing some mortgage risk from the federal government.

Currently, most mortgages come with five-year terms and 25-year amortization periods. At the end of the term, homeowners still owe a large amount on the mortgage, known as a balloon payment. Feldman says there is a mismatch between mortgage term and amortization, which means homebuyers must refinance or renew the outstanding balloon payments every five years.

"This creates a risk to both investors in mortgages and borrowers, if the lender is unable to renew the loan at maturity and the borrower is unable to find a new lender," he says. "If the federal government could facilitate a shift to longer mortgage maturities, borrowers and investors would be better protected from mortgage lenders that become insolvent."

He proposes a mortgage product that matures when it is fully amortized. It would include an interest rate reset and penalty-free right of redemption at least every five years. "However, in the absence of agreement on an interest rate reset and the failure of the borrower to fully repay the mortgage at that time, the mortgage would become a floating rate mortgage until it matures or is repaid, or until a new rate is set by agreement," proposes Feldman.

Such a product would help develop the market for residential mortgage-backed securities for uninsured mortgages, where an institutional investor would invest directly in a pool of mortgages without any government backing for repayment, he suggests.

HSBC Canada says a recent global survey found that Canadians are among the least likely to shop around for a better mortgage. Only half of Canadian mortgage-holders reported they shopped around to get a better interest rate or terms, compared the global average of 61 per cent. The most likely homebuyers to shop for a mortgage are in France 79 per cent, Malaysia 74 per cent and China 69 per cent.

With mortgage rates beginning to climb in Canada after a long period of historically low rates, 78 per cent of Canadian mortgage holders said they had never seen a rate increase on their current mortgage. But "like vinyl records and barber shops, higher interest rates may be making a comeback," says HSBC.

A Canada Mortgage and Housing Corp. survey conducted in the fall found that 82 per cent of current homeowners say they feel confident that they have the tools and information they need to handle their debt load.

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