The Canadian real estate market is freaking out about stress testing new buyers. There’s a lot written on the impact on new buyers, but no one’s talking about how it impacts existing owners. Everyone thinks this means game over for the banks, which made me curious, why didn’t the banks lobby harder to prevent this? Looking at the numbers, it’s because they didn’t have to. Mortgage stress testing across all segments has the potential to reduce customer churn, and boost profits. Meanwhile, existing owners lose a bargaining chip, potentially sending their rates much higher.
What Are The Stress Tests?
Starting January 1, insured and uninsured mortgage borrowers will need a “stress test.” This is a quick calculation to determine if you can pay your mortgage, if the rate jumps 200bps. In plain English, the maximum you can borrow is determined by a rate two percent higher than the contract. This reduces the maximum borrowing power by over 20%. Renewals won’t need to do this stress test, unless they’re switching banks. The last part is what we’re looking at today.
Number of Canadians That Need Stress Tests
Mortgage growth is pretty close to peak, and the Big Six Canadian banks own a majority of these renewals. Over 5.6 million mortgages on residential property were outstanding in Canada in 2016. At a 68% rate of homeownership across Canada, we’re getting pretty close to a peak rate of homeownership. The Bank of Canada calculates this debt to be worth CA$1.5 trillion. Interesting enough, over 74% of the dollar volume can be found in the Big Six filings. New mortgage growth is getting difficult, so retaining borrowers becomes the new priority.
Speaking of renewing, we’re approaching a very important window for borrowers. The stars have aligned, and over 47% of mortgages are going to be renewing within the next 12 months. Another 31% of mortgages will renew over the next 1 to 3 years. We have the potential peak of mortgage growth, and a huge number of renewals. All of this data is hitting us just a touch over 3 weeks from today.
Source: Bank of Canada.
Reducing Competition Is A Profitable Model
Typically a smart borrower walks down the street, and asks around for the best rate. They may never switch banks, but at least they can use that as a negotiating chip to lower their mortgage rate. Now banks can calculate in advance whether or not you can actually pass a stress test at a new bank. Bank of Canada estimates that 10% of uninsured mortgages issued last year would not pass the new stress test. These borrowers that won’t be able to pass a stress test, can’t just go to a mortgage broker for the lowest rate. They’ll get whatever the bank gives them at renewal, which can add up to thousands more in interest payments.
It Can Cost Highly Indebted Borrowers Thousands of Dollars
To illustrate how highly indebted borrowers are going to be screwed, let’s do a rate comparison. Officially, a 5 year fixed at Big Six bank is 4.99%. On a $800,000 mortgage, that would work out to $191,907 of interest paid after 5 years at that rate. Now, most people don’t get that – you might be able to negotiate it as low as 3.29% in our case. On a $800,000 mortgage, that works out to $125,715 in interest for the 5 year fixed term. You can save $66,192 at your own bank right now, just by negotiating. Although, your bank only went that low because the other lenders exist.
The best rate we could find from a mortgage broker without looking very hard was 2.84% on a 5 year fixed rate. On a $800,000 mortgage at 2.84%, you’re looking at $104,918 in interest. That’s $86,989 of interest saved over just 5 years, when compared to the standard rate. It’s also $20,797 lower than one of the best rates that can be negotiated in bank. That’s quite a bit of money, for just 5 minutes of looking around. An option that’s going to disappear in just a few months, for those that probably need to negotiate the most.
Source: Better Dwelling.
These discrepancies also exist before mandatory stress testing is rolled out across all mortgage types at banks. The reduction of churn can be great for the banks, but not so great for existing mortgage holders. Regulations are a mixed blessing, tackling one issue, while often creating another. The issue created, might mean many existing homeowners are going to see higher levels of debt. Good for banks. Not so great for mortgage holders that have been barely squeezing by.
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When the banks don’t make a noise about being regulated, you should have known there’s a catch. Great job pointing this out, everyone thinks this was just going to stop new homebuyers. In actuality, it’s a captive audience grab.
In Canada you don’t short banks. Banks short you.
Important to shop around for a good rate when getting a mortgage the first time. Also don’t get suckered into taking mortgages with lenders that provide introductory terms, and they spike later. People spend forever shopping for a car, but the interest on just 5 years of a mortgage is almost 5 times the cost.
You can literally save 10s of thousands of dollars over 5 years by shopping around. If take a terrible rate, you didn’t really earn that much in profit if you sell 5 years down the line and paid 10% the value of the home in interest.
If you have so little equity and/or income at renewal time that you cannot pass the new stress test, then you should be putting your home on the market. In other words, B20 is doing exactly what it is supposed to do. That is, improve the quality of mortgages everywhere by forcing not only marginal buyers but marginal owners out of the market. A secondary benefit will be reduced demand for housing and lower prices.
I think this another trick they’ve probably thought about. People that won’t pass stress test can lengthen their amortizations, which means they’ll pay even more interest.
Longer amorts will be next on OSFI’s hit list.
They already are: one of the “recommendations” is to qualify renewals at 25 year amortization (regardless of the actual amortization).
Notably borrowers can remain with their existing institution without having to requalify in any way (as long as they agree to whatever renewal rate that institution gives them). It seems pretty unlikely that given the choice between paying an extra 0.5% (or whatever) on their mortgage and selling, many will choose to sell. This free “premium” that Banks are allowed to charge is certainly a gift, especially when considered across thousands and thousands of Borrowers.
The suggestion that the intent of the policy is to force homeowners to sell (and that this is a desirable outcome) is remarkable.
I doubt that many will opt to sell. Most will opt to eat the extra 25 or 50 basis points. Of course, all that is assuming they aren’t able to pass the stress test. The stress test isn’t that draconian – at least 2/3s of renewals will have no trouble meeting it. The marginal ones who can’t pass it are collateral damage. And really, if they are riskier borrowers, than they should be paying higher rates.
That collateral damage could have been prevented if the BoC actually did its job and kept credit tight enough to prevent destructive asset bubbles (just another form of inflation that doesn’t show up in the CPI). This is a good example of what happens when you close the barn door after most of the horses are gone. But you still have to close the door. And if the BoC won’t close it, then OSFI and others will step up to close if for them. And yes, it will get slammed on the fingers of a few unfortunates.
I think you are missing the point of the article: it won’t force owners to sell, it will prevent them from switching lenders. And with literally no bargaining power, they will be stuck with whatever renewal rate their existing lender gives them. It also has *nothing* to do with equity.
It also creates the bizarre circumstance where the qualification standard is higher for borrowers with significant (20%+) equity than for borrowers with less. They are punishing middle class borrowers who have proven their ability to save!
You might argue that these aren’t intended consequences, but they are certainly inevitable ones.
So it sounds to me that OSFI is doing the job that the BoC should have done a long time ago – raising borrowing rates. Though in OSFI’s case it will only raise mortgage rates for higher risk borrowers who can’t pass an arbitrary stress test. By far a second-best solution, but better than nothing.
High ratio borrowers have been getting better rates than those with big down payments for years now. That has nothing to do with OSFI or stress tests. That distortion is created because high ratio borrowers (less than 20% down) qualify for CMHC insurance, meaning the banks immediately offload the risk to taxpayers and are therefore willing to give them better rates. Ask any mortgage officer or broker how many 19% down mortgages they’re doing these days – there is a very tangible reward for having a smaller (sub-20%) down payment. Exactly the opposite of the way it should be.
This distortion is proof that CMHC insurance is underpriced. CMHC premiums should be adjusted constantly to match market conditions – and should be priced at least to the exact point where whatever interest break banks give you for having the insurance is negated by the premium paid up front, and maybe even a bit beyond that. Fixing that distortion won’t lower costs for low ratio borrowers, it will increase costs for high ratio borrowers. Probably not the result you’re looking for.
You are ill informed. CMHC does not download the risk to the taxpayer, where do you people come up with stuff like that? It’s an insurance scheme, a premium is paid and a reserve fund created. There’s so much misinformation in these comments and ill intent actually, it’s really sad.
Oh right and in a severe risk-off market event the backstop for the CMHC is what? Fannie and Freddie?
There’s quite a bit of misinformation in your post – I’m not sure where to begin.
-“the lower rate” for high ratio borrowers only really started recently (with the last round of changes): prior to this, non-balance sheet lenders could get low cost insurance for most conventional borrowers, so rates were generally the same for conventional and high ratio borrowers (all other things being equal)
-whoever is doing 19% mortgages to get a better interest rate is doing their customer a terrible disservice (and I say this as a mortgage broker): the insurance premium at 80.01% starts at 1.80%, which is *far* more than the rate premium of ~0.50% for uninsured mortgages. They get a better nominal interest rate on their mortgage (bragging rights?), but the cost of borrowing is ~50% higher!
-so your last point is exactly backwards: the actual borrowing costs confirms that it is a lot more expensive to get High Ratio money, AND CMHC’s multibillion dollar profits (after payouts) suggests that they aren’t undercharging for anything. If it was such a bad bet, why would GE & CG be in the game charging the exact same premiums as CMHC?
Everything you said is 100% right, but don’t you think in long run it’s better for everyone to control how much people can borrow to buy a house?
We all know how herd mentality can make people do irrational things, specially when it comes to making money based on past tends.
In the good old days, the BoC used to do that by raising rates. However, with their almost single-minded focus on the CPI, which totally misses the inflation that is occurring in asset markets right now, they have kept rates low, and forced the hand of other regulators like OSFI. The fancy-shmancy word for that nowadays is “macro-prudential”. A rather nauseating term used by financial babblers to promote whatever latest regulation gong show they are cooking up. Really, “macro-prudential” regulations are nothing more than pathetic and largely ineffective stop gap measures to fill the vacuum left by central banks, who have all but abrogated their responsibilities to maintain a stable monetary base.
Are you saying of the 1.5 trillion dollars currently in Canada, 47% of them are up for renewal in 2018?
Not likely, 47% of mortgages is not 47% of dollar volume. I would think (hope?) that the really large mortgages would be locked in for longer periods of time and therefore less of them come up for renewal each year. I don’t pretend to know this for a fact, but it’s my inkling.
[…] Don’t Fool Yourself, Canadian Banks Are The Real Winners By Stress Testing Mortgages […]
I saw this coming and also seemed surprised the big 5 were not fazed by mortgage broker industry started acting very concerned last summer. (cause they get less switching)
BTW average mortgage rate last year by Canadians was 2.94% as per statscan http://www.cbc.ca/news/business/statistics-canada-family-income-survey-1.4437137
you seem obsessed with the BOC 4.99% rate- this is used for stress test and banks mortgage penalty calculations .
[…] Don’t Fool Yourself, Canadian Banks Are The Real Winners By Stress Testing Mortgages […]
[…] Mortgages were responsible for over half of all interest paid by households. Over $42.5 billion of interest paid in 2017 was on mortgages, an increase of 5.97% from the year before. This was the fastest pace of growth since 2014… just kidding. It was the fastest pace of growth since 2007. Expect this number to soar as interest rates climb, and OSFI B-20 reduces rate competition. […]
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