Variable Interest Rates and the Stress Test

Variable Interest Rates and the Stress Test by James Mckeown

Clients often have questions after hearing in the media how variable rate mortgages are set to rise (linked to the prime rate), but what they don’t realize is how fixed rates mortgage have been on a rocket to the moon for the past several months. 

Fixed rate mortgages are impacted by the bond market and not the prime rate, meaning they are free to rise and fall at anytime, not just set intervals. But how do fixed rates impact affordability, and what is the stress test?
Last updated in June 2021, the stress test requires that mortgage applications be approved at a rate of 2% above the contract rate, or 5.25%, whichever is higher. With some fixed rates exceeding 4%, the qualifying rate is pushed above the 5.25% benchmark, while the variable rate product from the same lender is often not. While almost half the cost today, variable rates are set to increase, and with record inflation, and other unknowns there are no guarantees when those increases will end.

A variable rate could be a very smart move, if you are in a position to afford increasing payments, as locking in down the road could still mean a higher rate than today. Variable rates are less advantageous to first time home buyers, retirees looking to downsize, or those looking to refinance. In today’s policy environment however, they may have no other option but to take the variable and its lower qualifying rate, in order to secure the extra money to purchase or get approved.

But why don’t we have 30 year amortizations for first time home buyers, or the ability to qualify at the rate you would be paying in the case of a fixed rate term? These changes could bring immediate benefit to buyers looking for a home and level the playing field with those who are purchasing to invest, but it would also push prices even higher as Canada is estimated to need up to 1.2 million additional housing units with plans to build only a fraction of that number. It’s simply not possible to increase ownership and limit dramatic price increases when we have a shortage of homes to begin with. Rising interest rates and the stress test may well be what ultimately limits the rise in housing prices to a more manageable number, but that’s cold comfort to those being pushed out of the market and left in a rental market with its own challenges. A policy designed to promote stability however should not be encouraging variable rate mortgages, and as long as that’s the case, the stress test simply makes no sense. 

Read the original article here.