Households will eat their stockings

Let’s talk about prices first. This is off topic for my column, but a little bit nonetheless. The Bank of Canada surprised us yesterday by raising interest rates by 1.00%, an unexpected move not seen since 1998.

It’s now at 2.50% and the climb isn’t over yet. Estimated target: 3.5% within one year. Remember that we started January at 0.25%.

To illustrate the impact of these increases, let’s use the adjustable rate mortgage, which is amortized over 25 years. The key interest rate has a direct influence on this. Every time it goes up 0.25%, it costs $15 more per month per $100,000 mortgage.

Since the beginning of the year, the burden of a $350,000 adjustable rate mortgage spread over 25 years has increased by $472.50 per month, or $4,670 per year. Interest only.

And it gets worse. Households will eat their stockings.

Now, getting to the heart of my subject: Imagine if there hadn’t been the mortgage “stress test” so decried by many players in the real estate market.

It would be a disaster.

A brake on real estate

You see, this damn test limited homebuyers’ ability to borrow. How many brokers (real estate, mortgages) said this move barred families from their dream of a courtyard bungalow on the outskirts of town?

In fact, the “stress test” has forced many households in hot sectors to compromise. They had to choose between relocating to a second-choice neighborhood or resorting to condominium ownership.

Yes, it is a brake on the real estate market. And thank God there was a “brake”!

– Listen to Alexandre Dubé’s interview with Daniel Germain on QUB radio:

The healing “buffer”

I explain this in more detail below, but the essence of the stress test is to apply a safety margin during the mortgage qualification process.

The lender must assess the buyer’s ability to repay, and this depends, among other things, on prevailing interest rates. As interest rates rise, the maximum mortgage a buyer can access decreases.

The test requires lenders to add 2% to the allowed rate in their calculation or to use the qualifying rate of 5.25% (whichever is higher).

It’s part of a series of measures introduced in the 2010s to ease the real estate frenzy. Launched in 2016, the “stress test,” as it’s known among neighbors, was originally aimed at holders of uninsured mortgages (less than 20% down payment). It has now been extended to all loans.

In a normal situation, when real estate is more balanced and no drastic rate hike is on the horizon, the move may seem excessive. In a market like the one we’ve seen recently, it has contained the rise in house prices and family debt. It also protected the financial system. Today she does her job discreetly.

It has been said that the envisaged safety margin of 2% is too high. In less than six months we surpassed it!

The stress test likely allowed the Bank of Canada to maneuver without sending the real estate sector into a meltdown.

The test in detail

Stress testing is a requirement of the Office of the Superintendent of Financial Institutions.

A mortgagor must meet two ratios, Gross Debt Amortization (ABD) and Total Debt Amortization (ATD). The latter is more complete. This includes all of the borrower’s monthly expenses (mortgage, other debts, car payments, property taxes, heating costs, condominium fees). The sum is divided by the monthly gross income. The result must not exceed 40% (it may be slightly higher depending on the lender).

The stress test artificially increases the cost of the mortgage, which reduces borrowing capacity.

The Financial Consumer Agency of Canada offers a tool to calculate how much mortgage you qualify for.

The tool is available on the Government of Canada website.

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