When Canada’s current Liberal government introduced the mortgage stress tests a few years back, the impetus behind it was legit and honourable. It was to prevent buyers from getting in over their heads with buying a home, and particularly if said home was truly unaffordable for them in the bigger picture. Especially if their income levels made it likely that they’d be in real financial difficulty if interest rates were to rise considerably anytime in the foreseeable future. Which is of course exactly what’s happened over recent months here in 2022.
Can we assume that there are many couples and individuals out there who have been saved from being in a predicament right now because of those stipulations? Absolutely, but there’s also evidence that suggests that the mortgage stress tests haven’t been as effective in the way they were intended either. It’s interesting to note all of this, and especially as those interest rate hikes have come at a time when the market is cooling based on a number of contributing factors.
For a real estate agent this is a trend that is interesting to look at as something of a third-party observer, and most will say that the mortgage stress tests have been worthwhile and that it’s important that prospective buyers have a very firm understanding of what they can really afford when beginning to work with the realtor’s preferred mortgage broker. Good realtors always work to make their clients entirely informed about everything related to buying a home, and here at Real Estate Leads our online real estate lead generation system is an excellent way of ensuring they have the clientele base they need.
Turning back to the topic at hand, let’s look at how the mortgage stress test and its realities are actually playing out here in the 3rd quarter of 2022 and how things haven’t necessarily played out as planned. Because with mortgage rates now north of 4% and 5%, and very likely approaching their peak for this rate-hike cycle, it is fair to ask if changes to Canada’s stress test are needed.
Follow England’s Lead?
Earlier in August the Bank of England did away with is mortgage affordability stress test, and some industry experts wonder if it might be time for Canada to do the same. What these tests do is require both insured and uninsured mortgage borrowers to prove they will be able to meet monthly mortgage payments based around a rate of 5.25% or two percentage points higher than their contract rate—whichever of the two is higher. It is common these days for borrowers to be stress-test at rates that are at or exceed 6% and 7%.
Here in Canada the stress test for insured mortgages (ones with a sub-20% down payment) was first introduced in 2016, and it was then followed up with the Office of the Superintendent of Financial Institutions test on uninsured mortgages, or those where the down payment exceeded that 20% number. The idea was to logically assess risks seen by government and regulators where high household debt was meeting high real estate prices, and then being joined by the historically low interest rates that we have seen in Canada for a long time up until recently.
But here we are now with home prices dropping across the country, and being way down from the peak reached earlier in February of this year. At the same time interest rates have gone up significantly as the Bank of Canada tries to reign in record inflation rates that have some worried about a repeat of the 1980s.
Lock Out
Ask folks at Mortgage Professionals of Canada and they’ll tell you that with the current market realities the mortgage stress tests are actually working to lock Canadians out of the market. 2020 and 2021 saw much in the way of opportunities for buyers to get into home ownership with locked, fixed money, but these buyers were blocked from doing that by the stress test being so much higher than the actual available rates. Therein lies the crux of the problem, and although that might be less of problem now with lower median home values the potential for it being problematic again is something to consider.
Variable versus fixed-rate mortgages becomes an issue too. Fixed-rate does offer homeowners more stability on their mortgage payments, but qualifying for these mortgages was more difficult until recently. You would have a typical fixed-rate mortgage of 4.45% stress-tested at two percentage points higher—6.45%. The wealthier might have no problem with trading extra cash for security, but for more shallow-pocketed first-time home buyers who wanted into the market it wasn’t such an easy choice.
And with stress test qualification rules, fixed rates started rising well ahead of variable rates earlier this year and this forced many borrowers into variable rates. The reason being that was all they could qualify for. The Canada Mortgage and Housing Corporation (CMHC) has data that shows nearly 60% of mortgages taken out earlier this year were variable-rate products.
There was a forced shift to variable-rate mortgages simply because would-be buyers were being stress tested at 5.25%. Then when you have the Bank of Canada hiking interest rates by 100 basis points on July 13, those variable-rate mortgages are looking much less desirable. Some feel that the Department of Finance and OSFI should be re-calibrating the exact requirements of the mortgage stress test, and there are many in the real estate business who would concur that is in the homebuyer’s best interest in the bigger picture for both them and the real estate market as a whole.
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