Current mortgage qualification rules could lead to future crisis—analyst

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The existing regulatory regime governing mortgage qualifications in Canada has severe shortcomings that could lead to “over-leveraged” home owners and a future market crash, according to a Toronto-based analyst.
In his recent analysis, independent mortgage broker Calum Ross observed that would-be buyers could secure a mortgage only if they can successfully make payments based on the current qualifying rate set by the Bank of Canada—currently at 4.65 per cent based on the posted 5-year fixed rate, as reported by Romana King for MoneySense.
But while buyers with variable-rate terms (i.e., 2.4 per cent) have to prove to lenders that they can fulfill monthly payments based on the 4.65 per cent rate, “home buyers who opt for a five-year fixed rate are exempt from having to qualify at the posted rate,” according to Ross.
“These buyers can qualify at the discounted rate,” he added. The discount rate is set at 2.8 per cent as of 2015, and the exemption Ross pointed out was confirmed by the Department of Finance in an email saying “…borrowers with five-year fixed-rate mortgages may qualify based on their contract rate.”
Ross warned that this loophole might rear its head come renewal time for the 5-year fixed terms, which can compound the already startling rate of growth in household debt in recent years.
“Even a 1% increase in mortgage rates will hit homeowners hard, as this translates into an almost 40% increase in interest rates,” the broker said.
It’s not a fate set in stone, however, as the said loophole is actually poles apart from the “teaser rates” in the U.S., which are mortgages that are offered at low rates but then subsequently spike up to more crippling levels.
“Thankfully, regulations governing Canada’s banks and mortgage loans are actually quite different than in the United States, and far more stringent, but that doesn’t mean this current mortgage qualification loophole doesn’t pose a threat to the stability of Canada’s housing market,” the analysis concluded.

[Erratum: The previous version of this article quoted Ross as saying: “Even a 1% increase in mortgage rates will hit homeowners hard, as this translates into an almost 40% increase in their monthly mortgage payments.” The correct statement should read: “Even a 1% increase in mortgage rates will hit homeowners hard, as this translates into an almost 40% increase in interest rates.” Apologies for the error.]

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  • Ron Butler on 2016-06-29 10:32:16 AM

    Okay I just ran the numbers and if the client's rate went from 2.49% to 3.49% using 30 year amortization and semi annual compounding the monthly payments increased precisely 13.5% not 40%. A 3.00% increase to 5.49% would cause a 43.1% increase in payments. The interesting thing is 5.49% in 5 years is not impossible and then yes, many Canadians might have a heck of a time making their mortgage payments.

  • Dianne Chafe on 2016-06-29 10:33:41 AM

    It is important that you advise your clients how much their payment would be if the rate were to rise to the 4.65% in 5 years. If they divide that over 5 years and increase their payments each year they will be fine.

  • David Larock on 2016-06-29 10:54:26 AM

    This article omits a key point - mortgage balances are lower at renewal, and this helps cushion the impact of higher rates on future payments.

    Today, a $500,000 five-year fixed-rate mortgage at 2.49% amortized over 30 years has a monthly payment of $1,970.

    Assuming that only minimum payments are made over the initial five years, that borrower’s balance at renewal would be $440,182.

    If that borrower then renews into a five-year fixed rate at 3.49% amortized over 25 years, their new payment would be $2,195 (which is an 11% increase – hardly a wallet-busting increase for most).

    Also, if that borrower was under financial strain, he/she could refinance that balance into a 30-year amortization instead, which would make their new monthly payment $1,968 (which would be $2 less than their original payment, despite the 1% rise in rates).

    Not sure how this leads to the “future crisis” the headline warns about?

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