With interest rates skyrocketing, why are so many borrowers still choosing adjustable rate mortgages?

According to some brokers, federal rules aimed at controlling financial risk in the mortgage market are encouraging some buyers to choose variable rates despite the rapid rise in interest rates.

The bar for passing the Ottawa Mortgage Stress Test is currently likely to be lower if you choose a variable mortgage than if you commit to a fixed rate. This, in turn, means that a variable rate allows you to qualify for a larger mortgage.

“It’s quite counter-intuitive, I would say, since fixed rates are more stable, less risky,” said James Laird, co-CEO of Ratehub Inc., which runs financial product comparison site Ratehub.ca. and has its own real estate mortgage brokerage.

“This is unusual and, I expect, the situation we find ourselves in was not intended by the decision-makers,” Mr Laird added.

Mortgage stress testing requires federally regulated lenders to test borrowers’ finances against rates above the mortgage rate offered by their lender. The goal is to ensure that they would be able to meet their payments even if interest rates were to rise significantly above their current mortgage rate.

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Currently, borrowers must qualify based on the higher of a benchmark rate of 5.25% or their contract rate plus two percentage points.

With five-year variable rates in the 2% range and many five-year fixed rates at around 4%, the rules mean variable-rate borrowers only need to reach the 5.25% threshold, while many fixed-rate mortgage applicants face a qualifying rate of 6% or more, said David Larock, a Toronto-based mortgage officer at TMG The Mortgage Group.

Each percentage point increase in the stress test threshold reduces the maximum amount homebuyers can borrow by about 10%, Laird said.

That’s why buyers who need to borrow as much as they can afford to afford the property they want often choose variable rates these days, despite the risk of rising rates, he added. .

RATESDOTCA, which allows Canadians to compare mortgage and other rates online, said about half of the mortgage inquiries it receives now are for variable rates.

Federal regulators introduced the current minimum eligibility rate of 5.25% as a new, higher floor for the stress test in June 2021, amid widespread concern about an overheated housing market fueled by housing costs. record loan. The latest stress test rules apply to both insured mortgages – those with a down payment of less than 20%, which require mortgage loan insurance – and uninsured loans with a larger down payment. .

The Office of the Superintendent of Financial Institutions (OSFI), which oversees the stress test for uninsured mortgages, has committed to reviewing the qualifying rate at least once a year, each December.

However, OSFI and the Department of Finance, which oversees stress testing rules for insured mortgages, left the floor rate unchanged in December 2021.

In comments to The Globe and Mail, OSFI dismissed the idea that stress testing rules are the reason for the continued popularity of variable rates among borrowers applying for uninsured mortgages.

“In the current rate environment, borrowers who choose variable rate mortgages do so, overwhelmingly, because they can potentially cost significantly less than a fixed rate mortgage. Cost and risk appetite are the main drivers behind borrowers choosing variable rate mortgages in the uninsured space,” the regulator said by email.

Although the stress test only formally applies to federally regulated lenders such as banks, even provincially regulated lenders such as credit unions use these parameters to screen mortgage applicants for their the most competitive rates,” Mr. Larock said. Failure to do so would encourage borrowers who don’t qualify under federal rules to flock to credit unions, which would increase financial risk for those lenders, he added.

Variable rates generally rise or fall as a result of adjustments to the Bank of Canada’s overnight rate. Many analysts expect the central bank to raise its key rate from its current level of 1% to 2.5% by early 2023 in a bid to rein in runaway inflation.

Many variable rate mortgage holders in Canada have fixed payments. But any upward movement in rates further increases their interest costs, which results in a smaller portion of mortgage payments being applied to principal, which lengthens the time it takes to pay off the loan. For others, an increase in rates also means a larger monthly payment.

On the other hand, going for a fixed rate right now carries the risk of locking in a high rate and missing out on possible future rate cuts, Larock said. In particular, borrowers who register with the big banks, which typically charge steep penalties for breaking a fixed-rate mortgage, risk “finding themselves stuck behind an iron door”, he said. .

Still, variable mortgage holders need to be financially comfortable with the interest rate risk associated with floating rates, he added.

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Leslie M. Gill