There are a lot of different headlines right now with predictions on interest rate trajectory, bubbles or market collapses. The stories often speak to different jurisdictions, from Canada as a whole, to large cities vs small, and then the US. We saw in 2008 that our banking systems are quite different. I mention that as a warning because there are some scary opinions right now of the American real estate market.
I want to remind you of the “Stress Test” for Canadian mortgages. It’s a requirement that was implemented in 2016 and it’s been tweaked since then. The spirit of the rule was to ensure that a borrower getting a very low interest rate could qualify for a higher rate…It was inevitable that rates would go up and it was a method to protect borrowers from default.
I’ll use some rough figures. Let’s go back a few years and imagine a buyer is qualifying for a mortgage with an interest rate of 1.90%. The stress test requires a borrower to qualify for the higher of 5.25% or their rate plus 2% (3.9% vs 5.25%). Interest rates are in fact higher than 5.25% today, but close enough that borrowers should (in theory) be able to find a way to manage their new payment. I’ve heard many mortgage brokers are extending the amortization period to help make the payments more manageable until rates go down.
We also need to keep in mind that although we don’t want to see anyone go into default, only a portion of owners are likely to be at risk. I went looking for real numbers. 2021 census data for the Lower Mainland indicates there are 1,179,020 owner and tenant households with income greater than zero (total households was 1,196,480). 71% of those households spent less than 30% of income on shelter costs. They (owner-occupant or landlord) will still feel pain at mortgage renewal time but a few lifestyle tweaks will keep their payments manageable. The remaining 29% will obviously experience it differently. We hope they find solutions that keep them in their homes.
This doesn’t necessarily mean the overall economy is well-protected. Canadians historically prioritize mortgage payments and will continue to do so. All other household spending is going to get reduced or cut until interest rates go down. Overall economic activity is likely to decline while homeowners focus on their mortgage payments.