Why I Found Last Week’s Change To The Mortgage Qualifying-Rate Puzzling

Last week the Bank of Canada quietly changed its Mortgage Qualifying Rate (MQR) from 4.64% to 4.74%.

As a reminder, the MQR is used to qualify Canadian borrowers who are applying for either variable-rate mortgages or for fixed-rate terms of less than five years. (Here is a link to my post that explains in detail how the MQR works.)

While this is a relatively minor change, it still worries me. For starters, the MQR has been raised at a time when mortgage rates are falling, so this change has not been made, as it usually would be, in response to market forces. More importantly, this is the first lending-policy tightening since the federal Liberals won their majority last fall and as such, it gives us our first insight into how our new political leadership is likely to handle the mortgage file.

Regular readers of my posts will know that I have been supportive of the entire series of mortgage-rule changes that have made over the last several years. To me they have all been a matter of short-term pain to protect longer-term gains, but this change, minor as it is, is harder to rationalize.

Here are five questions/concerns that I have about last week’s MQR change:

1. Do our policy makers know that this change will have virtually no impact? While I see the wisdom in applying a tougher qualifying test for borrowers who opt for mortgage types and terms that come with more interest-rate risk, the MQR is already more than double today’s prevailing market variable and shorter-term fixed rates. While these rates may well rise in future, it seems unlikely to me that, for example, a borrower who opts for a two-year fixed rate at 2.19% will have to renew at a rate anywhere close to 4.74% in two years’ time. As such, I don’t think raising the MQR from its already lofty level makes our lender’s mortgage portfolios any safer in any but the most unlikely ‘Mars-hits-Earth’ rate-rise scenarios.
2. Did our policy makers intend for this change to funnel more borrowers into five-year fixed rates? Raising the MQR tilts the playing field even further in favour of the five-year fixed rate because borrowers who apply for this term only have to qualify at their contract rate, which today is in the 2.39% range. When the MQR has been raised to the point where it is just about double the prevailing five-year fixed rate, our policy makers are effectively pushing borrowers in to five-year fixed rate terms, which I call the banker’s favourite because these mortgages are normally the most profitable main-stream mortgages that lenders offer. Should our policy makers be using such a heavy hand to direct consumers toward the bank’s preferred product? Especially when so many Canadian borrowers have saved a bundle on interest costs by opting for variable and shorter-term fixed rates over the past twenty-five years?
3. Don’t our policy makers know that most borrowers are taking a five-year fixed rate now anyway? As a corollary to the point above, now that borrowers can’t get much of a discount for taking on the interest-rate risk inherent in variable and shorter-term fixed rates, the vast majority of our mortgage borrowers are already opting for five-year fixed rates. So why do our policy makers feel the need to use the MQR to push borrowers into five-year fixed rates when market forces are already doing that anyway? Are they not aware that this is the case, and ultimately, shouldn’t consumers be the ones to make that call?
4. Did our policy makers raise the MQR just so they look as though they are doing something to mitigate housing bubble concerns? If so, that worries me because a) this change does almost nothing to address those concerns in any meaningful way, and b) housing-bubble talk has been around for a long time. We have been fortunate since the start of the Great Recession to have policy makers who look through the noise in the markets when making policy changes instead of succumbing to the headlines of the day. (Love them or hate them, I think that the four rounds of substantive lending-rule changes under Jim Flaherty and his federal Conservative successors have held up well over time.)
5. Could the MQR raise be a signal that a much bigger policy change is ahead? There has been some speculation that our regulators might soon require all borrowers to qualify using the MQR, including those who apply for five-year fixed rates. This would be a disaster because it would have the same impact as an instant doubling of real interest rates. Instead of continuing to use a scalpel to smooth out the rougher edges of our housing markets, this would be like taking a sledgehammer to it. I’m not saying this is likely to happen, but if it did, it would help to explain why the MQR has been raised at a time when rates are falling, and when the vast majority of borrowers are opting for five-year fixed-rate mortgages, instead of for the variable and shorter-term fixed-rate mortgages that are affected by this change.

Five-year Government of Canada bond yields fell five basis points last week, closing at 0.52% on Friday. Five-year fixed-rate mortgages are available in the 2.39% to 2.49% range, depending on the terms and conditions that are important to you, and five-year fixed-rate pre-approvals are offered at about 2.54%.

Five-year variable-rate mortgages are available in the prime minus 0.40% to prime minus 0.50% range, which translates into rates of 2.20% to 2.30% using today’s prime rate of 2.70%.

The Bottom Line: I found last week’s small rise in the MQR to be puzzling. Maybe it will come to nothing but I have concerns about why our policy makers would raise the MQR when the posted rates that it is supposed to be based on are falling, and especially when doing so affects so little of today’s demand. Time will tell.