With interest rates set to increase in the year ahead, the demand for alternative lending will grow, says Steven Tulman
Working in the mortgage industry is an eye-opener, and one thing we have all been keeping an eye on is the upward trajectory of the remarkably low Bank of Canada overnight rate.
With continued supply chain issues and still-rising inflation, it came as no surprise that the BOC finally raised its overnight lending rate on March 2, for the first time since October 2018. While the increase was only 0.25%, bringing the new overnight rate to 0.50%, there is no doubt in my mind that more rate rises will be announced in the next few months.
What causes the BOC to increase the overnight rate?
The BOC is responsible for applying monetary policy by adjusting the overnight lending rate to control short-term interest rates, and it uses this power to manage inflation and keep the Canadian economy on a healthy path.
It’s clear to me that since high inflation tends to hurt economies overall and individuals financially, the BOC needs to step in to help manage the situation. Many expect it to continue increasing the overnight rate to reach 1% by this fall and 1.5% in early to mid-2023.
How will this impact mortgage rates?
With this first of several expected increases, the prime mortgage rate will likely follow suit. What this means is that variable mortgage rates and variable home equity lines of credit will increase, since they are tied directly to the prime interest rate. Fixed mortgage rates, however, are not tied to the prime rate. Instead, chartered banks base most of their decisions on the bond market when setting fixed rates.
Banks base their fixed mortgage rates on the interest they earn from their investments in bonds. They use the money they earn from bonds to help offset the losses they incur on the mortgage side. Since Canadian bond markets continue to yield high returns, we have seen regular increases in fixed mortgage rates since mid-2021 and expect this trend to continue throughout 2022.
How will rate rises affect borrowers?
Since June 1, 2021, the stress-test qualifying rate has been 5.25%. This means borrowers wanting to pass the mortgage stress test are required to qualify at the greater of either their contract rate plus 2%, or 5.25%, which is the benchmark rate used to qualify borrowers for both insured and uninsured mortgages.
With interest rates expected to keep rising throughout 2022 and even 2023, the stress-test qualifying rate will also likely increase. This will make things more difficult for homeowners looking to refinance their mortgages through traditional banks and AAA lenders to access available equity in their homes.
At Clover Mortgage, we have already seen a strong push toward the alternative lending space as home prices soared in 2021, and a steady increase in alternative ‘B’ mortgages and private lending. The recent and upcoming rate rises will further exacerbate growth in demand for alternative lenders.
It’s safe to say that credit unions, trust companies and private lenders will be taking away business from the banks. I’ll add that mortgages from alternative lenders tend to come with additional costs and higher interest rates. Not all borrowers will be able to afford, or be willing to pay, the extra costs.
Many hopeful homebuyers may reconsider and delay their purchases, which might lead to increased inventory and reduced buyer competition in the real estate market. Although this could lead to a slowdown in housing price growth, we should not expect to see decreases in home prices any time soon.
How can the government make mortgages more affordable?
There are a few key things the government can do to help homebuyers afford their mortgages:
- Reduce or remove the stress test
- Reintroduce the 40-year amortization and allow uninsured mortgages to qualify on the full 40 years
- Allow CMHC and other mortgage default insurers to increase the maximum amortization period from 25 years to 30, 35 or even 40 years for qualifying insured mortgage applications
It will be interesting to see how the next year or two will play out, but I believe we’ll see increased growth in the alternative lending space in the short term, and increased amortization periods down the road.
Steven Tulman is the president and co-founder of Clover Mortgage and Zenvest Capital. As a seasoned entrepreneur with over 20 years in the finance, marketing and technology sectors, Tulman uses his diverse business background to help revolutionize the mortgage experience for Clover Mortgage’s customers as well as mortgage brokers.
