July 17, 2022 | 12:58
BoC Takes a Hammer to Housing
The Bank of Canada's 100 bp rate hike sets us up for an even deeper correction in housing through next year. The fact that the market had already cracked after the BoC’s initial move in rates only reinforced how sentiment-driven the market was, and how quickly that can change. Here are a few big-picture takeaways for the mortgage and housing markets:
Actual mortgage rates climbing: Variable mortgage rates are now around 4% (mileage will vary), up from around 1.5% at the start of the year. Recall that variable rate mortgages jumped to more than 50% of new lending early in the year, which was a meaningful shift for the Canadian market following a period of hefty fixed-rate activity earlier in 2021 (also below the 2% mark). Five-year fixed rates continue to hover around or slightly above 5%, so the mortgage yield curve is flattening quickly, but the broad housing market is now being priced with cost of funds around 4.5% on average—a major shift in a short period of time.
Qualifying rates now ratcheting up: With variable rates now around 4%, this week’s move by the BoC has cranked up the stress testing hurdle (the higher of the contract rate plus 200 bps, or 5.25%). Before the move, variable-rate borrowers were still generally qualifying at the 5.25% mark, but that has now shifted up to around 6%. Fixed-rate borrowers are qualifying around 7%. So, unlike previous rounds of tightening, this move now also begins to carve into purchasing power on paper.
The valuation stress is real: As outlined above, the Canadian housing market has gone from being incrementally priced at a 1.5% cost of borrowing, to now around 4.5% within the span of six months. This is a massive pill for the market to swallow. True, many will say that “4.5% mortgage rates are still historically low—mortgage rates climbed well into double digits at the tail of the late-1980s boom”. Indeed, the posted rate then reached 14.25% in 1990 when the market cracked, up from 11.75% six months before. But, it’s the change that matters in dictating shifts in market pricing. In fact, going from 1.5% to 4.5% on the same loan value would crank the monthly mortgage payment by almost 40%, making the current episode an even more abrupt shift than the late-1980s after adjusting for income levels. This is not to say the market will suffer the same fate, as the ensuing 1990s had a lot of other things go wrong.
Rate re-sets a headwind: Past borrowers coming off five-year fixed rates are now in for at least a modest upward reset later this year. Five years ago, fixed-rate mortgages were being taken around the 3% level, so coming into a 4.5% world will lead to a monthly payment increase of roughly 15%, all else equal. Meantime, the vast majority of borrowers currently on variable-rate mortgages have fixed payment features, but
Psychology: In an abrupt turnabout, more Canadians now expect lower home prices ahead than higher prices, and that was before the BoC’s 100 bp hammer. Based on weekly survey data from Nanos, just 30% now expected higher prices as of the July 8th week, which has cratered from almost 70% at the height of the pandemic boom.