Will mortgage stress tests disappear in a high rate environment?

The latest data from ratehub.ca shows that higher interest rates are pushing up mortgage stress test amounts by some $18,000 per borrower or couple. Stress tests are pushing up the costs of borrowing and are forcing many prospective buyers to opt for variable rate mortgages instead of fixed rate mortgages given the cost increases. Ratehub.ca is predicting that fixed-rate borrowers would face a stress test rate of 7.21% given that the rate has increased by two-thirds in the last four months, which is why the most stretched borrowers are opting for variable rates. The OSFI, or Office of the Superintendent of Financial Institutions, the federal banking regulator, raised the stress test rate in response to higher overall rates to protect the banks from risky mortgage borrowers.

The Canadian mortgage stress test applies to anyone applying for a mortgage, refinancing their current home loan, or renegotiating the terms of their mortgage contract with a federally regulated lender. And while provincially regulated lenders have more flexibility when it comes to mortgage approvals, many still use the test to evaluate customers’ financial risk. This means that most home buyers in Canada are subjected to the stress test. Think of the stress test as a set of rules major banks must use to determine if you qualify for a mortgage. Because mortgage rates can fluctuate, as they have in recent months, the Canadian government has set a minimum qualifying rate to reduce the risk involved in mortgage lending. This helps to ensure you’ll still be able to afford your mortgage payments if interest rates increase beyond the rate originally stated in your contract. In other words, it’s not you but your finances that are put to the test.

Real estate analysts are calling on the federal government to implement a review of the stress test and how the OSFI sets the stress test rates. The mandatory stress test rate set the qualifying rate on uninsured mortgages at either two percentage points above the contract rate, or 5.25 per cent, whichever is greater. Some analysts are calling for longer mortgage terms or looser rules on mortgage changes. Stress tests requirements are adding tens of thousands of dollars to mortgage amounts across the country. Where sale prices and mortgage amounts are greater, the stress test amount grows.

A recession is acceptable to the BOC to kill inflation

The BOC’s terminology for its 1% interest rate hike calls these big increases “front-loaded.” A massive increase now staves off the need for multiple rate hikes in the future. BOC Governor Macklem has used strong language repeatedly in his messaging and interviews. To “choke off the excess” demand from the economy and help starve inflation, Macklem has vowed that the BOC is willing to go “as far as it needs.” Macklem pointed to tight labour markets, supply chain issues, and strong post-pandemic demand potentially pushing inflation over 8% for a prolonged period. He effectively acknowledged that if Canada has to suffer through a mild recession to excoriate inflation, it will be worth it. A recession would give the underlying economy time to recover, restructure, and plan for longer term productivity to catch up with the strong demand that is fueling inflation.

Macklem also bravely acknowledged that getting inflation back to normal will take a good deal of time, and that it “this is not going to be without some pain.” Finally, he claimed that the potential for a soft landing (brief economic slowdown without recession as rates go up) had “narrowed“, accepting that a difficult recession is now more likely than before. More and more experts see that it is inevitable that rates will continue going up past July. Josh Nye, a senior economist from RBC sees rates hitting 3.25% by October. By the BOC’s own fundamentals, taking interest rates to this level would be actively harmful to economic growth and would slow things down.

RBC ‘front-loaded’ talk of a recession with a report predicting that Canada will go into a recession in 2023 that will be ‘short-lived’ and not as punishing as previous recessions, such as the 07-08 crisis. RBC sees unemployment rising modestly to just over 6.6% with the economy recovering fully by 2024. RBC also expects house prices to fall 10 per cent in the year ahead, subtracting more than $800 billion from household net worth. Like Nye, RBC sees the BOC taking rates to 3.25% by the end of the year.

The impact of a 1% rate hike

The Bank of Canada’s July 13th full artillery barrage reverberated across the community and in the international financial markets. Expectations of an inflation number of 8.3% to come, not seen since 1981, prompted the massive move by the institution. No-one predicted a 1% increase, with most seeing a 75 basis point increase as likely, and a few assuming a 50 basis point hike. Fiscal and inflation hawks welcomed the increase, seeing it as absolutely necessary given inflation continues to rise. Not since the economic and dot-com boom era of the late 1990s has Canada seen such a massive and sudden increase in the cost of money.

The impact of the hike was immediate for variable rate mortgage holders and borrowers. Prime rates went up in response, and therein so will the cost of servicing other pools of debt. Only fixed rate mortgage holders were spared from the increase. Some examples of mortgage cost increases reflective of the Jul. 13th hike are below:

  • $500,000 mortgage: $16,000 in new costs over 5 years
  • $750,000 mortgage: $24,000 in new costs
  • $1,000,000 mortgage: $32,000

On a modest $400,000 mortgage taken out over 25 years at 3%, monthly costs would come to just under $1,900 a month. But at 4%, these costs increase to over $2,100 a month. That $200 may not be much for a lot of people, but for many who are heavily indebted, feeling the effects of inflation, or stretched for income, it can make a massive difference in how they live. There are more and more stories of Canadians who took on floating rate mortgages now switching to fixed rate mortgages, even if it costs them more in the short term because of the anticipation of more rate increases being on their way. If you’re looking to change your mortgage and you’re self-employed for example, consider the options and flexibility of a private mortgage with Tembo in Ontario.

For years, Tembo has provided second mortgages to self employed clients who need access to their cash ASAP. Many of these clients need loans for debt consolidation, renovations, deposits for the purchase of a new home or something else. Tembo has helped hundreds of clients receive equity advances through private second mortgages often within 48 hours*. This is a great tool if you need your money quickly and don’t want to wait weeks or may not qualify with a bank.

Self-employment has been rising steadily in Canada since 2008, with 2.5 million self-employed Canadians then and almost 3 million recorded by Statscan just before the pandemic hit. Getting additional debt or a mortgage as a self employed Canadian can be complicated. Some banks require the purchase of default insurance ahead of any possible approval of a mortgage worth over 65-90% of equity. They can also require extensive documentation of at least two years of accounts and bank activity for self-employed people. If you’re self-employed and are in need of an equity advance, or any financial solutions through a private second mortgage, please visit www.tembofinancial.com and give us a call at 1-844-238-6717!

Why the BOC could do a fast 180 on rates soon

We turn now to the U.S. to inform our readers of an emerging narrative suggesting that the traders who correctly predicted that the Fed would go hyper-hawkish on rates are now sensing the potential for rate cuts – due to the economy rapidly softening. Bond traders are now expecting a rapid cut in rates as early as mid 2023 if the economic hit of past and coming rate hikes is too great. Expectations of U.S. rates going up as high as 4%  are now anticipating a 3.3% rate by Q1 2023. Gang hu, a senior banker at Winshore Capital Partners summed up the logic behind these views succinctly: “Markets are saying recession is coming, inflation will slow down, commodities will fall and the Fed will cut rates in 2023, it’s hard to fade it because this story line is consistent. It can be a self-fulling process.” All of this should unfold and reverberate in Canada; potentially affecting very similar outcomes.

Recession fears kicked in quickly for the oil markets, prices are now beginning to plateau as the expectation of slowing demand and a recession builds. With 30 year fixed rate mortgage costs in the U.S. having doubled recently, the impact on real estate and housing starts is already being felt (6% rates for 30 year mortgages haven’t been seen in over a decade). The U.S. economy continues to slow, and much of the loss of confidence is being reinforced by more and more projections of a slowdown in Q2. The Atlanta Fed’s GDPNow tracker now points to a 1% contraction for the second quarter, following a 1.6% slide in GDP in the first three months of the year. By the end of 2023, some traders see rates going down to 2.7% after the first round of rate cuts that could come. Jay Powell and other apparatchiks in the Federal Reserve system have repeatedly said that they will be nimble with their rate actions, but that for now, rates will keep going up until they see clear evidence that inflation is coming down. In other words, flexible hawkishness.

Some see rate cuts coming as early as the end of this year, not in mid 2023. Michael Yoshikami, founder of Destination Wealth Management, said as much to CNBC: “Inflation is runaway right now. The Federal Reserve is going to bring out these multiple very, very strong signals that they’re looking to control inflation, it is going to dip the economy into a slow growth, stagflation or a recessionary environment and then I think the Fed going to start cutting rates again later on this year. If the Federal Reserve moves us closer towards recession and breaks the back of inflation and has to cut a little bit to simulate the economy.” Tembo predicts that the economic and commercial synergies between the U.S. and Canada will see many of the predictions outlined in this article unfold with the actions the BOC could take in the coming months.

An ocean of buyers is waiting on the sidelines

Despite rates going up, inflation remaining high, and prices surging, the real estate market in Toronto and much of the GTA is still rock solid. While sales and listings are starting to fall, prices are still going up in the city. A recent Desjardins report warning of price declines of up to 15% in the outer rim of the GTA and in small town Ontario specifically cited that pieces in Toronto and the GTA would plateau or decline by extremely marginal amounts by the end of 2023. The resilience of the regional real estate market is tried and tested. Despite these conditions, there are a huge number of prospective buyers who are waiting for prices to decline so they can buy a home and enter the market. Nation-wide home values have increased by 50% over the past two years, numbers in hot markets like Toronto and Vancouver have been even more impressive. Even a hypothetical small 10% decline in prices in Toronto would be a fraction of what the gains have been recently.

Real estate projections for 2022 all went out of the window once inflation kept rising and rates were raised far too late in response. What was once a sellers market for ages has now started to shift toward buyers. Some are arguing that this is a negative and a harbinger of declining prices and less dynamism, while others are saying that this is a healthy rebalancing after almost a generation of sellers making consistent and ever higher profits. Tembo has repeatedly written about the vast number of prospective buyers who continue to build up their savings, lower their debt, and improve their employment prospects to qualify for healthy mortgages and to prepare for their final buy-in into the real estate market. The market is beginning to healthily shift toward those who can pay higher monthly payments with higher mortgage rates and who have solid jobs. These are people who were aspiring upper middle class members but who didn’t have enough down payments for solid properties in the downtown core given the immediate post-COVID boom in prices.

More and more of those waiting buyers are now apparently planning to wait even more, until September for example, anticipating further cooling or even some marginal price declines for some assets. Economists and realtors across the spectrum are commenting that the impact of rate hikes has been significant, but has sunk in faster than they had anticipated. A Senior Economist from Scotiabank made the following comments on rate hikes in an interview with the Globe and Mail: “The rate hikes were meant to remove some of the exuberance from the market, which they are doing – admittedly, however, they are doing so at a much faster pace than previously anticipated.” At the end of the day, there are little to no projections of big price declines in Toronto, and there is still a tremendous amount of demand waiting for the right moment.

Cooling market + Tembo = Opportunity

Rates are going up for the foreseeable future. We’re in a tightening cycle that will continue until inflation begins to see a sustained decline. Experts predict that rates will go up until 2023, when they will begin to fall again. The expectation is that an economic slowdown and coming higher rates should serve as a powerful joint anchor to inflation. With inflation out of the way and the economy in a tougher state, Central Banks will lower rates again to stimulate our way back to economic and financial stability. This is the trajectory some see coming. So how to play these conditions?

Homeowners who have been prudent and who have seen years of equity growth are well positioned to leverage their housing assets to buy more. Why not take out a private second Tembo mortgage for a down payment? Good real estate deals will be plentiful in the months ahead and the ability to move quickly to put forward a down payment and make an offer will be a huge asset over slower bank approvals – Tembo can approve you for a second private mortgage in Ontario in as little as 48 hours. A private second mortgage by Tembo offers you tools and options you can lean on instead of using your cash, HELOC, savings, or other sources of funding for your down payment.

This is a good moment to consider purchasing a cheaper home in a smaller town or rural area (especially communities with historically low unemployment rates or large densities of public sector employment) in need of some upgrades. Your private second mortgage with Tembo can be advantageous in that it can massively boost your purchase home’s value if used to remodel a kitchen or basement ahead of a sale. Tembo has helped many clients accommodate renovations that have helped them net thousands more on the sale of their properties. Realtors and market experts are consistent in outlining that a remodeled kitchen and finished basement can add tens of thousands of dollars to the value of a home. Don’t lose out on the added equity Tembo can unlock for you in as little as two days! Call us today for more info 416 238 6717 or info@tembofinancial.com

Higher rates are coming, consolidate your debts today with Tembo

Rates keep going up and the expectations are that rates will only start coming down again in late 2023 to get us out of a potential recession. How fast rates go up and how quickly will define our economy and politics for years to come. Individuals and families who will head off the higher rate environment and minimize their costs will thrive and prosper in the coming years. Through this higher interest rate environment, please don’t hesitate to keep Tembo’s ability to offer rapid, creative, and innovative lending solutions in mind – whether you’re looking to renovate and increase equity values, or you need to consolidate and simplify your debts, or you need a quick second mortgage for a deposit on a new or additional property. Higher interest rates means greater risks and costs for banks which means slower processing, greater scrutiny, and more limited options.

On Jun. 15th 2022, the Fed raised rates by 75 basis points. This was the highest increase for the U.S. central bank since 1994. Expectations of the BOC doing the same are rising, especially on the heels of the May inflation number set to be released on June 22nd. Looking at our interest rate history, rates are still historically low. From June 2004 to August 2007 when economic conditions were excellent and inflation low, rates increased from 2% to 4.25%.  Always keep in mind that the historic norm since the early 1960s has been rates of some 6%, we’re only at 0.50% right now. From 1997 to late 2000, rates increased from 3% to 5.75%. From 1987 to May of 1990, rates jumped from 7.3% to 13.8%. This was in the aftermath of strong inflation and the popping of the late 80s real estate bubble that Tembo has written about many times. Keep an eye on inflation and the BOC and always keep Tembo in mind for a second mortgage, debt consolidation solutions, an equity advance for a renovation loan, and so much more.

So, the conclusion is that when the bank starts to shift to higher rates, it generally sticks to that trajectory over a number of years. There are usually at least a handful of rates over the higher rate period. Increases have historically been .25 basis points, but even in good economic conditions, rates have been occasionally boosted by .50 basis points. In periods of high and growing inflation rate increases are stronger and the ‘higher rate period’ is shorter than in periods of healthier macroeconomic fundamentals. Take advantage of your increased housing equity to consolidate your debts, pay down liabilities fast, and simplify your payments – please visit www.tembofinancial.com and give us a call at 1-844-238-6717!

Why the market will persevere

It’s hard to predict what the future will bring in a world as dynamically turbulent as ours these days. This is an era where everyday brings a new challenge, a new development, and above all – huge fast paced change. Interest rates going up and inflation creating challenges represent the biggest obstacles that our real estate market has faced since the 07-08 recession. 2008-2010 represented a period where recession driven real estate demand fell and was briefly stagnant in the market. From the mid 1990s to the present demand has always been strong with that one outlying exception. There is no reason why demand won’t continue to remain strong in the coming years and decades – immigration is one reason, a shortage of houses is another. A recent study by Scotiabank found that two-thirds of the national shortfall in homes was concentrated in Ontario. Ontario is over 1.2 million homes short to reach the G7 average of houses per capita (homes per people). At the same time, over 2 million people are projected to settle in Ontario over the next decade. We need at least 1.5 million homes to accommodate this increase in the population, let alone to bridge the housing gap that already exists.

Despite all the pressure on governments and builders to get more supply on the market, Ontario builds 70,000 homes per year, we are at least 30,000 houses a year short of meeting the most basic of demand trajectories. These forces are the reason why average home prices in the GTA soared from just under $600,000 in 2015 to $1.4 million this year. Low interest rates and an open market massively compounded price growth. A decade ago the average house price in the province at large was $330,000, now it is $923,000, truly spectacular growth. While average house price growth reached 200% over the last decade, incomes rose by less than 40%. Even in the event of high rates, a recession, and  a slowdown in prices, demand will stay strong. Prospective buyers waiting on the sidelines will jump in, immigrants will keep coming in (even if in smaller numbers), and there will be plenty of job opportunities in a number of different fields.

If we do head into recession territory consumption will go down and there will be a slight cooling of demand which should slow prices down for goods and services down and cool business investment. This will lower inflation and take pressure off of the BOC. The end result will be lower interest rates and more affordable mortgages. On the supply front it’s also important to note that housing starts have been rising under the Ford Government from 100,000 to over 140,000 units under construction. Little by little some of the supply constraints are being addressed and results are starting to trickle in. A PC majority win in the election will be a strong supply boon for housing.

On the Bank of Canada’s credibility

There’s no doubt that the BOC’s standing has taken a bit of a beating. The BOC is now openly being criticized by politicians (largely on the right wing of the spectrum), and by some in the media and in the financial world. From the start of COVID, Tembo was thoughtful of the inflation implications of post-pandemic spending. We also were openly skeptical of the BOC’s claims that any inflation would be transitory. We wrote repeatedly about the inflationary potential of the enormous sums spent to fight COVID and of the dislocation to supply chains around the world. We are now monitoring media reports of the potential for BOC Governor Macklem to embark on extra high rate hikes to taper inflation faster and to compensate for the very late increase in rates we’re now seeing. Tembo also repeatedly wrote on the big gap in the BOC avoiding raising rates in early 2022 despite inflation going up month after month in late winter and early Spring.

There are now whispers that the BOC is firmly committed to going ahead with three consecutive half-percentage-point hikes over a three-month span. The first of which as we know came in mid-April, with most expecting the second one set for early June, and with a third likely due in the first half of July. To the BOC’s credit, it has acknowledged that it was off. Recently, Deputy Governor Carolyn Rogers went further: “Tough questions, added scrutiny and informed debate are entirely appropriate in the current environment.”  We also have to be cognizant of the influence the federal government has over the Bank of Canada, and they appear to be increasing that influence and imposing more of their power over the institution. The BOC has increasingly been weighing the importance of maintaining maximum employment and fighting climate change – and many feel that this has been directed on the institution by the Federal Treasurer Chrystia Freeland.

Federal Conservative Leadership Candidate Pierre Poilievre took a lot of flak but also got a ton of media attention by saying he would fire Tiff Macklem if he ever became Prime Minister. Poilievre has repeatedly said that Macklem is a weak Governor of the BOC who is completely submissive to the Federal Liberals and that he lacks independence. Poilievre has repeatedly cited that the federal government created the inflation problem through $400 billion in pandemic stimulus, and that Macklem facilitated this by buying up government bonds and keeping the BOC “accommodative” to big spending agendas. Poilievre’s comments were the strongest criticism of the BOC or a BOC Governor in Canadian federal political history. This all rests on how the Canadian economy and housing market fare over the next while. Too rapid a rise in rates could kick start a recession or a housing market freeze – or both. Stagflation would be devastating to the BOC and to the federal government politically. At the end of the day, no one wants to be blamed for messing around with the golden goose.

A big rate hike to kick off June

The latest gift to Canadians from the Bank of Canada is a 50 basis point rate hike in June. Politicians, news headlines, economist surveys, and banking executives all take it as a given that the BOC has no choice but to jump up rates to tame inflation which has been stubbornly strong in recent months. The last time the BOC unleashed back-to-back 50 basis point rate increases was in late 1997 and early 1998, a time of rapid economic growth and a booming stock market but with low inflation – a product of the dot com boom. There are also strong expectations that rates will go up again in July, with a brief pause, and then followed by another rate hike in September. Some economists see the BOC bank rate at 2.5% by September. Even if this hypothetical scenario plays out it is important to note that those rates would still be extremely low by historical scenarios.

For those who are concerned about rate increases, keep in mind that throughout late 2018 and 2019 rates were held steady at 1.8%, and before 2008 rates were well over 4%, we’re still in a very comfortable position. The BOC will be under titanic pressure to keep coming rate increases reasonable given the economic and public debt conditions which COVID exacerbated. The rising rate environment we’re now in has seen the pace and intensity of real estate offers slow down. Realtors have repeatedly spoken about the 180 degree change in the market, with properties that once received 12 bids now down to 2. This pause is a strategic opportunity to recalibrate. Given that fewer and fewer homeowners are selling their properties and we’re seeing supply dry up even more so than before. This is leading to prices still going up and not plateauing as one could expect. The dry up of supply and the positive front on prices shows that many of the underlying forces driving demand are still out there: people with cash, good jobs, good credit, and wanting property. Rising rates don’t mean people won’t want homes.

Use this pause to renovate your home! Or take advantage of the high equity you have to consolidate debts. A Tembo loan to renovate can help facilitate a simple project, like finishing up a basement, or polishing up a kitchen, or it can underpin large-scale changes: landscaping overhauls, a complete appliance overhaul, energy retrofits, structural changes or building add-ons, or a combination of many different projects at once – Tembo is flexible. The pause in the market now is a great opportunity to maximize value. Even a basic, standard overhaul of a kitchen with new appliances and marble finishes can add tens of thousands of dollars to the value of your home and can be accomodated quickly and affordably at Tembo. Do not underestimate the potential of your home and the home renovation options you have at your disposal in this market. A Tembo home renovation loan can be a complete game-changer.