Canadians looking for new mortgages are finding the landscape very confusing as both changes in government policy and commercial bank competition work in somewhat opposition directions. The interactions of these two developments have slowed mortgage lending, threatening to reduce home sales further, especially in the large metropolitan regions.

First, let's look at the role of government in altering the landscape. The Federal government introduced new mortgage lending rules, effective January 1, 2018, that upped the requirements to qualify for a mortgage loan. Now borrowers have to prove that they would be able to cope with interest rates substantially higher than their contract rate— the so-called “stress “test. Mortgage Professionals Canada, an industry group, estimates that more than 100,000 homebuyers, who would have qualified in the past, would likely fail the stress test and would have to either reduce the size of their loan request or abandon their application entirely. Many of these potential buyers will turn to the unregulated mortgage market, comprising mostly of private lending institutions or lightly regulated financial institutions who are not subject to these stringent rules.

The Federal government and its regulatory arm, the Office of the Superintendent of Financial Institutions, denies that they have had a role in influencing the new higher rates, arguing that the marketplace determines borrowing rates. However, it is hard not to come away with the view that the government is not displeased with the higher borrowing rates. For some time, Federal authorities have voiced concern about this current cycle of rising house prices and have tried to talk down prices without any success. Now, they are using their regulatory powers to influence market behavior.

As a consequence, mortgage growth is slowing. The Canadian Real Estate Association reports that national home sales volume sank to the lowest level in more than five years in April, falling by 14 per cent from the same month last year. The national average sale price decreased by 11 per cent year-over-year. The chartered Canadian banks, who account for over 75% of mortgage lending, are experiencing a very pronounced slowdown in mortgage growth; loan growth was a meagre 0.2 percent growth since the start of the year.

Second, the slowdown in mortgage lending has changed the competitive nature of lending such that seems confusing to the average borrower. Taking their cue from the rates on 5-year government bonds, the commercial banks have increased the popular 5-year fixed mortgage rate. The posted fixed rate is set by the Bank of Canada and has increased to 5.34 per cent, although borrowers have been generally able to negotiate much lower rates on a case-by-case basis.

These higher fixed rates have spawned competition in the variable rate market. All chartered banks have increased their fixed rates, but at the same time, have dropped their variables rates, thus causing confusion among prospective borrowers. Competition among the large banks has ignited a variable rate war, such that the variable rate is now at 115bps below the prime rate of 3.45%. This puts the variable rate a full 100bps below that of the five-year rate. So, the banks raise one set of mortgage rates only to drop another set of rates. No wonder there is some head-scratching among borrowers. The borrower must choose between paying higher fixed interest payments over a five -year period or assume lower interest payments, initially, but run the risk of higher interest payments in the future should the prime rate increase dramatically. No wonder the mortgage industry is so unsettled.