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Residential Market Commentary - Qualifying rate conundrum
Credit: First National Financial LP
The Bank of Canadas Qualifying Mortgage Rate has popped back onto the real estate radar. Back in July, the central bank lowered the rate for the first time in nearly three years.
The idea behind the QMR is to ensure that home buyers will be able to afford their mortgage as interest rates rise in the future. It is a stress test that sets the lowest theoretical interest rate the buyer will be charged. That rate is significantly higher than any actual rates being charged by mainstream lenders.
The Bank of Canada bases the qualifying rate on the five-year rates posted by Canadas Big Six, federally regulated banks. The number is rather arbitrary, though, because the big banks do not actually charge their posted rates. The real rates are markedly lower. The posted rates tend to have more to do with the penalties charged when a home buyer breaks their mortgage before the end of its term.
There is no obvious standard for setting the qualifying rate. A well known Toronto mortgage broker uses this illustration: two years ago the yield on Government of Canadas five-year bonds was 1.42% and the QMR was 4.64%. Earlier this year, five-year bonds were back at 1.42%, but the QMR was 5.19%.
It is important for consumers to know that the current rules around the qualifying rate tend to favour the big, federally regulated banks. For example, the QMR stress test is not applied when customers renew their mortgage with their existing, federally regulated lender. This can have the effect of trapping customers who might otherwise be able to take advantage of lower rates with a different lender.
Many in the mortgage industry have been calling for more transparency and consistency in the QMR rules in order to make them fairer and simpler.
The Contagion of Fear
Fears of a possible coronavirus pandemic are sweeping the world. Markets are jittery with little hard data to go on.
With the first case now reported in Canada, many are recalling the 2003 SARS where Canada was one of the epicenters. Arguably the biggest (economic) lesson from that experience is that fear is the biggest risk to the outlook.
The impact of the SARS pandemic on the Canadian economy is difficult to estimate, confounded as it was by the slowing US economy, the invasion of Iraq and other events, but the Bank of Canada estimated -0.6ppt hit to annualized growth in Q2-2003, or just over 0.1% on the level of GDP.
While it is premature to predict the path of todays coronavirus outbreak, we estimate that a SARS-equivalent pandemic today could have a similar impact on the Canadian economy with an estimated hit of just over 0.1% on the level of GDP by mid-2020, at which point a pandemic should be contained. This estimate is subject to a significant degree of uncertainty with risks skewed to a potentially larger impact.
The effect should not be significant enough to trigger a broader economic malaise, but could this finally push Governor Poloz over the line to proactively stimulate the economy in his next rate call?
Bank of Canada maintains overnight rate target at 1 ¾ percent
The Bank of Canada today maintained its target for the overnight rate at 1 percent. The Bank Rate is correspondingly 2 percent and the deposit rate is 1 percent.
The global economy is showing signs of stabilization, and some recent trade developments have been positive. However, there remains a high degree of uncertainty and geopolitical tensions have re-emerged, with tragic consequences. The Canadian economy has been resilient but indicators since the October Monetary Policy Report(MPR) have been mixed.
Data for Canada indicate that growth in the near term will be weaker, and the output gap wider, than the Bank projected in October. The Bank now estimates growth of 0.3 percent in the fourth quarter of 2019 and 1.3 percent in the first quarter of 2020. Exports fell in late 2019, and business investment appears to have weakened after a strong third quarter. Job creation has slowed and indicators of consumer confidence and spending have been unexpectedly soft. In contrast, residential investment was robust through most of 2019, moderating to a still-solid pace in the fourth quarter.