The mortgage market has certainly had its fair share of Government intervention over the years and everyone from the First-time Homebuyer to the buyer looking to move up and even investors looking to provide affordable housing options for renters. It has been a tough couple of years.
In looking for solutions, I have noticed something very peculiar and it has me thinking something odd is going on…but you be the judge.
Over the past 6 months the wholesale mortgage interest rates have fallen like a rock from 3.69% to 3.04% today and we are evening seeing 2.89% for 5-year money. WOW!! That is a 22% drop in rates.
You might be saying, that’s awesome as it works well for the consumer. Under normal circumstances I would agree, but this is anything but normal.
I’m sure you have heard of the ‘Stress Test’ that home owners have to go through when qualifying for a mortgage. This stress test uses the Bank of Canada Benchmark Rate which is simply the mode average of the big 5 Canadian bank’s posted rate. Today that Benchmark Rate, or Mortgage Qualifying Rate (MQR) as some like to refer to it, is sitting at 5.34%.
Here’s where things get interesting… this would be the time to get a bowl popcorn.
On May 10, 2018 that Benchmark rate increased from 5.14% to 5.34% due to mounting pressure from the bond market. Right after the increase the 5-year bond yield moved from 2.11 to 2.33 hitting a 7 year high before settling back down 2.11 days later.
Fast forward to today, that same 5-year bond yield has fallen to 1.33, yet the Benchmark Rate remains at 5.34%. It was back in June of 2017 when we last saw the 5-year yield at 1.33 and at that time the Benchmark rates was 4.64%.
In my estimation, the Benchmark rate should be around 4.69%, but we are just not seeing that today. Why?
Great question!!
I see one of three possible scenarios.
Scenario #1.
Keeping the post rate high at 5.34% allows the big Banks to offer deeper discounts. For example… a 5-year fixed rate offering to 3.04%, means a discount of 2.30%. Historically speaking, we are use to seeing discounts in and around 1.8% on average.
But as consumers, we want to drive that fixed rate as low as possible. I have already shared that today we can find a wholesale rate of 2.89% and as a consumer we go back to the Bank and demand it. Banker says sure and we walk away laughing. Sound familiar?
But are we really laughing or is it the Bank that is laughing?
By driving the fixed rate down to 2.89%, we have just drove the discount offered by the Bank up from 2.3% to 2.45%. Would it surprise you if I told you that the higher the discount, the higher the potential IRD penalty? That’s right, should you break the term of that mortgage before maturity, that IRD penalty can be massive! The joke may really be on us, the consumer.
So the question I asked myself knowing all this was…
By keeping the Benchmark qualifying rate artificially high, would Canada’s big Banks find themselves more profitable than the profit resulting from more Canadians being able to get into the housing market by simply lowering their Posted Rates, which in turn would lower the Benchmark Rate?
***Important to note… the Posted Rate for a wholesale lender is their wholesale rate. Their IRD penalty calculations are about one quarter this size of a big Bank penalty, on average. Click here for more on mortgage penalty calculations
Scenario #2
Did the Department of Finance reach out to the big Banks and ask them to keep the Bank Posted Rates artificially high to help them achieve their goals
Fueling the economy by limiting home ownership. I won’t get into this as it is another post on its own.
Scenario #3
Or is it just a coincidence that bond yields have fallen 31% in the past 6 months, yet the Bank of Canada Benchmark hasn’t moved?
I have an opinion, but you don’t care about my opinion so I will keep it to myself. This is where I turn to you and ask…
Is it a Conspiracy? Is it Collusion? Or is it all a Coincidence?
In the meantime, what we can expect is that consumers will continue to drive their rate offering as low as possible and banks will gladly oblige knowing they are driving up the discount of their Posted Rate… the larger the discount, the larger the IRD penalty. And for those who are on the cusp of qualifying and could use the help of a lower mortgage qualifying rate, you might have to wait a little longer.
Quick note… at the time this post was written, the big Banks Posted Rate was 5.34%. On Saturday, two days ago, RBC announced that they lowered their 5-year Posted Rate to 5.19%.
Until next time.
Jeremy
