As interest rates have spiralled ever higher since March -- and are certain to be hiked once again on September 7 -- would-be homebuyers’ purchasing power is steadily decreasing.
In fact, the average borrower can expect to see their affordability whittled by more than 10% in the near future, according to lending experts.
Rob McLister, mortgage analyst at Mortgagelogic.news, recently wrote in a note that should the central bank pass on a 50-basis-point increase in their next rate announcement, he anticipates a 12% drop for a household earning $100,000, compared to the rates they had access to prior to the July 13th hike.
“Rocketing rates have taken a voracious bite out of mortgagors’ buying power. And it’ll likely get worse before it gets better,” he wrote, pointing to a recent aggregate affordability measure from RBC that pins levels at their worst-ever nationwide.
“This nonstop constriction of mortgage amounts is all too real for the seven out of eight homebuyers aged 25 to 44 who rely on home financing. About two-thirds of them purchase as much home as they can afford, according to CMHC.”
“This loss of leverage could easily take down CREA’s average home price more than 20% from the peak, readily eclipsing the 18.6% decline we saw in 2017-19,” he added.
While the Bank of Canada’s trend-setting Overnight Lending Rate has been rising by leap and bounds in recent months, only now will the true financial pain be felt, as mortgage rates have surpassed the threshold for the mortgage stress test rate of 5.25%. (Borrowers are either qualified at this rate, or their contract rate plus 2%, whichever is higher. With today’s variable and fixed rates now in the 4 - 6% range, that now means all new borrowers are having to satisfy the latter criteria.)
Jerome Trail, mortgage broker at The Mortgage Trail, tells STOREYS that this considerably changes the qualification game.
“We’ve always had to add this premium, because the government always assumed that we were in a lower than normal interest rate range, or at least the regulator did,” he says
“With the stress test, it should have basically prepared everyone, as the term implies, for when rates go up -- how is this going to impact people, can you afford to hit this? Well, in fact, right up until very recently, people should have been fine.”
In terms of how the math shakes out, he uses the example of a borrower with a 4.3% rate and household income of $200,000. At the stress test rate of 5.25%, that borrower would qualify for $1.2M in mortgage financing, giving them an overall buying budget of $1.4M, assuming a $280,000 down payment.
Today, with that same borrower stress tested at 6.3%, they’ll now only qualify for around $1M in financing.
“So if you still used that $280,000 worth of down payment, then their budget has gone from $1.4M to $1.28M,” says Trail. “We’re basically talking about a 10% change if you do it that way.”
A Proportional Perspective
Leah Zlatkin, LowestRates.ca expert and licensed mortgage broker, says that borrowers effectively lose $20,000 of purchasing power for every 0.5% increase, based on a $100,000 salary. However, she adds, for today’s new borrowers, it’s all relative.
“There’s two sides to this story,” she says. Number one, from an inflationary or inflammatory point of view, this is horrible, people can afford so much less, this is really getting out of hand. But from the other side of the perspective, you have to look at the pie, and how big the pie really is. If housing costs are going down, and you can now buy a house for a lot less than you could buy a house for before, proportionally, you’re still ok… Proportionally, you’re still in the same place you were in before.”
In the near term, it’s the borrowers who are already holding variable-rate mortgages -- especially those with floating rate products that are directly impacting by the BoC’s movements -- that are most feeling the burn.
“If you had a mortgage already, then yes, your payments are getting more expensive,” she says.
“But if you’re looking to go buy something, again, it’s this proportional story. You’re requiring less of a mortgage because effectively you’re buying a house for cheaper, and while the interest rate is a little bit higher than it was a few months ago, you’re probably borrowing less money than you would have borrowed a few months ago, because people typically borrow at their cap.”
Making the Most of Existing Affordability
That’s not to say buyers are necessarily stuck with shrunken budgets; all the mortgage experts point out that skilled industry professionals are using a little innovation to extend clients’ purchasing power if need be.
Trail says a common tactic at his brokerage is to qualify clients with a variable rate -- which, due to their lower price point, have more favourable stress test conditions -- and locking them into a fixed product the day after closing, should they desire.
Zlatkin says there are many lenders who will consider tweaking qualification requirements, such as extending debt ratios and amortization periods. There are also lenders -- such as certain credit unions -- who are not under the purview of the federal regulators, and do not have to adhere to the stress test.
“There’s lots of options, it just may result in a higher rate. There’s always a bargain to be had -- are you going to pay more short term, or are you going to borrow more long term,” she states.
“So just because the stress test is quote-unquote changing, just because the qualification criteria are changing, doesn’t mean you can't afford your dream home, it just means you need to understand the rules around what qualifying for your dream home are.”