While people barely manage the inflation and overpriced items, salaries remain the same, but the Bank of Canada consistently hiking the rate of interest.
Canada's mortgage stress tests last year looked overdone but underwhelming. Recent rate hikes by the Bank of Canada put many adjustable-rate borrowers at rates above stress-test rates. BMO cautions that these borrowers have not been tested for the current environment.
Stress testing is a feature designed to ensure that mortgagors can continue to pay even if interest rates are higher. The rate is 2 points plus your contract rate or the OSFI trial rate, whichever is greater. Few were enthusiastic about it, and many in the industry felt the test was too steep. It's not enough yet.
In 2021, when mortgage rates were at 1.5%, a stress test rate of 4.79% to 5.25% was tested against most. That's great news if you set this rate and continue to receive the discount. However, more and more borrowers are opting for adjustable-rate mortgages in exchange for taking on more risk at a 0.2 percentage point discount. Not the best decision.
BMO warns that yesterday's rate hike will wipe out mortgage borrower-tested rates. “The Bank of Canada’s 50 bp rate hike will push variable rates further above stress-tested rates for many mortgage holders,” BMO senior economist Robert Kavcic wrote.
He warns that interest rates for variable-rate mortgage borrowers have risen by 400 basis points (bps). Borrowers on variable-rate mortgages may pay more than the amount tested. That means borrowers are in uncharted waters, ill-prepared for current risk mitigation programs.
Canadian borrowers aren't enjoying the situation, but it's not a tragedy either. “Of course, the majority of variable-rate mortgages have fixed-payment features, so they are not being hit with the full force of payment hikes immediately (renewals will be another story),” he says Kavcic.
Typically, variable-rate mortgage payments stay at the same level, and the amount applied to the principal is reduced. In some cases, the borrower reaches the trigger rate. This is when a payment no longer covers sufficient principal payments, and an adjustment is required.
Lenders often adjust the trigger rate by increasing payments or extending amortization. Paying more interest can be a hassle, but it's not the same as losing a home at an affordable price.
How long mortgage rates stay at this level will determine the magnitude of the impact. "The longer mortgage rates stay in the range above 5.25%, the greater the pressure," the bank warned.
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