The mortgage market is highly driven by movements in interest rates. Higher interest rates increase the cost of financing across all different segments of the real estate market. For many individuals and businesses, an increase in interest rates is significantly impacting affordability and investments in the market.
Homeowners locked into fixed mortgage rates are temporarily exempted from higher mortgage rates until their mortgage terms expire and they need to renew their housing loans.
However, mortgages with variable and adjustable rates are already experiencing a shift in the composition of their monthly payments toward their principal and interest rates. A careful review will show that with variable mortgages, although monthly mortgage payments may remain the same, a higher percentage goes toward mortgage interest rates compared to principal repayments.
Regarding stress tests, the Canadian government requires most financial institutions to assess the ability of new home buyers to afford their mortgage payments. The stress test uses a qualifying rate that is typically higher than the mortgage contract rate. As of 2022, the qualifying stress test rate is the greater of the mortgage contract rate plus 2% or 5.25%.
A higher interest rate limits the value of homes banks can approve for potential buyers. It is already more difficult to qualify for a home purchase when interest rates are high. The stress test factoring an additional 2% into the current high mortgage rates exacerbates the housing affordability concern.
Homeowners who need to refinance their mortgages, switch to a new mortgage lender, or even take out a home equity line of credit are also impacted by increasing interest rates in the mortgage market. Renewing a mortgage in these times will increase your out-of-pocket home expenses, leaving you with less disposable income.
With five-year fixed mortgage rates reaching new heights, closing a new mortgage will have significant financial implications for the average Canadian.
In addition to higher interest rates, the competitive real estate space is pricing Canadians out of the market. Recent reports show that home sales declined by 3.9% in September compared to August, and newly listed properties fell by 0.8%. The housing market statistics are not surprising, given that the new housing price index is up by 6.3% compared to last year.
Inflation rates are still high; the consumer price index (CPI) was 6.9% year over year in September. Although the rate was down compared to August, it is still high compared to the 4.4% level in 2021. With the government of Canada’s target inflation rate being 2%, interest rates may continue to increase.
Reaching a record high of 3.75%, the policy interest rate has increased by 350 basis points in 2022, albeit gradually over six months since March. With the new interest rate announcement and Monetary Policy Report on October 26, the current situation around inflation, exchange rate risks and global disruptions suggests that the Canadian government will continue to combat higher consumer prices with quantitative tightening via interest rates.
That being said, the interest rate adjustments could either be accelerated or dampened depending on the outturn of inflation in the coming months. The Bank of Canada increased the rates by only 50 basis points in October, lower than the 75 basis points market analysts expected.
The continuous increase in prime lending rates will keep impacting the mortgage market directly. However, there are a lot of uncertainties and how consumers react to the housing market depends on the underlying economic policies and how lenders respond accordingly.