The mortgage stress test faces its first big challenge in this year of soaring interest rates.
The regulators behind the stress test generated massive pushback from the housing-industrial complex, but they were dead right to worry about the impact on homeowners of rising rates.
Unfortunately, the stress test offers false comfort to individual homeowners. It may help protect the financial system by preventing a rash of defaults, but it offers no assurance people can comfortably manage a big increase in mortgage payments.
We are now in a period of mental adjustments on home ownership, starting with the idea that a big mortgage is a noble burden because you own an asset that rapidly gains value. Facing a combination of higher living costs and rising debt payments, home-owning young families are the demographic with the most money stress today. Falling home prices means there’s no moral victory for all this pain.
Some quick thoughts for homeowners under pressure from rising mortgage costs: You need to think in increments of $100 in terms of the financial steps you take to save money. We’re way beyond lattes here.
Go down to one vehicle from two, take a 12-month break from contributions to tax-free savings accounts or registered retirement plans, cancel your cable TV and limit yourself to one subscription service. Talk to your mortgage lender about refinancing to extend your amortization and thereby decrease your monthly payments, and move to monthly payments from accelerated biweekly. Paying your mortgage off a little later than expected is a fair trade for gaining a margin of comfort at a time where living costs keep soaring.
Understanding the predicament of young homeowners starts with the fact that mortgage stress tests provide no safeguard against financial hardship. Introduced in 2016, the stress test requires buyers to be able to afford the higher of a rate of 5.25 per cent or the rate offered by their lender plus two percentage points.
With five-year fixed rates around 5 per cent today, buyers choosing that option need to be able to afford payments pegged at 7 per cent. Variable rate mortgages are around 4 per cent today, so buyers must be able to afford roughly 6 per cent.
The problem with the stress test is that it’s a snapshot of your finances before you purchase a home. In other words, a point in time where your financial profile is at its cleanest and most presentable.
As everyone who owns a home knows, your finances change for the worse after you buy because of growing demands to spend. You buy furniture and appliances after you move into your home, you improve and renovate, you buy a car, you have children.
These financial commitments often result in monthly costs that were not part of the financial assessment you underwent when you bought your house. The household cash flow that helped you ace the stress test may now be going to your car dealer and daycare provider.
A Bank of Canada report issued in June said people who bought homes in 2020-21 could see their monthly payments increase by a median 24 to 45 per cent, depending on the type of mortgage, when they renew in 2025-26. In dollar terms, the increases ranged from a median $300 to $1,020. Average hourly wage increases, which lately hit 5.2 per cent, may help homeowners carry the load, and so might career advancement or job switching.
But it’s unrealistic to expect the recent crop of homebuyers to manage their finances in a way that leaves them with hundreds of dollars’ worth of slack to be used to offset higher mortgage costs. The 8.1-per-cent inflation rate reported for June just adds to the strain on families.
Economists saw signs in the inflation numbers that suggest increases in the cost of living were reaching a peak. If so, then it’s possible that the period of adversity for young homeowners may be close to done in 18 to 24 months. Do what you have to survive the 2022 financial grind, but keep in mind that it will end.
Are you a young Canadian with money on your mind? To set yourself up for success and steer clear of costly mistakes, listen to our award-winning Stress Test podcast.
PERSONAL FINANCE COLUMNIST
The Globe and Mail, July 27, 2022