RBC weighs in on why Ottawa can afford to loosen up
The mortgage stress test’s minimum qualifying rate (MQR) is set for potential adjustment on December 15. With interest rates having reached their peak and the chances of another rate spike dwindling, Ottawa may now have the elbow room to ease up on the MQR without exposing borrowers to risks.
While the mortgage stress test has been a thorny issue for most since it was rolled out in 2018, experts agree that getting rid of the test altogether is out of the question. Federally regulated lenders had to find a way to ensure borrowers would be able to withstand a spike in interest rate, Royal Bank of Canada economist Robert Hogue explained. The mortgage stress test did so by using an exaggerated qualifying rate – the higher value between 5.25% and the client rate plus 2%.
Naturally, an inflated qualifying rate meant many potential home buyers found themselves with lower borrowing credentials than they thought they deserved, while others found they were no longer qualified to get a mortgage from a federally-regulated lender at all – at least for the time being. Even stronger borrowers were negatively impacted, as the stress rate pulled down the maximum value of the mortgage they qualified for.
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But the test has fulfilled its purpose of protecting against a rate shock, the Royal Bank of Canada pointed out.
When interest rates fell to historic lows, lenders knew better than to take them at face value. Instead, they tested borrowers against a potential, significant interest-rate increase – and rightly so, as low rates often translated to bigger chances of an increase over the term of the mortgage.
This was exactly what happened over the past year, when the Bank of Canada imposed a sudden and aggressive policy-rate increase of over 300 basis points in just eight months, after the country had grown used to a record-low 0.25% rate for most of the pandemic. The ‘shock’ borrowers are now facing is precisely what the mortgage stress test buffered the market against, proving both its efficacy and the enhanced resilience of the Canadian financial system in the process.
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But here’s why Ottawa can afford to slash the MQR in half and still fulfill the purpose of the mortgage stress test, according to the Royal Bank of Canada. Ever since the Bank of Canada adopted its inflation-targeting policy in 1991, the five-year fixed mortgage rate – the most common in Canada – only broke above the current qualifying rate 16% of the time.
In contrast, since the mortgage stress test was rolled out at the start of 2018, the mortgage rate stayed above the qualifying rate – which was then around 5.3% – 50% of the time.
The 2% buffer imposed by the MQR could be cut down by 100 basis points to 6.7% – representing the current market rate of 5.7% plus a 1% buffer – and remain ‘very stringent’. The five-year fixed rate has exceeded it less than 25% of the time over the last 30 years, it was highlighted.
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Economists are by no means advocating the elimination of the MQR. Apart from having proven its use over the past year, more rate hikes in the future cannot be ruled out given the uncertainty still shrouding the inflation rate and its targeted return to 2%. All Ottawa needs is to loosen up when current and expected market circumstances give it the space to do so.
Do you think the MQR can afford a 100-basis-point cut? Let us know in the comments.
