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Housing Market - Stress Test

Mortgage Professionals Canada Renews Calls to Tweak Stress Tests

Mortgage Professionals Canada has renewed calls for changes to the federal government’s stress tests, arguing they pose serious risk to the housing market and overall economy.

The association’s annual report on the state of the mortgage market, authored by its Chief Economist Will Dunning, followed up on previously published concerns over the federal government’s mortgage stress tests.

It noted that housing markets across Canada slowed significantly in 2018 due to a combination of higher  mortgage stress tests, higher interest rates and other policy changes that have “constrained” home buying.

The report notes that resale activity fell an annualized 11% in 2018 and was down 15% from the all-time high in 2016.

“The mortgage stress tests are raising the risks to house prices and the economy of Canada,” Dunning wrote in the report, adding that falling house prices pose one of the greatest threats to a modern economy due to impaired consumer confidence.

Not only that, he says regulations intended to remove risk from the housing market are actually having an opposite effect by driving a greater share of buyers to alternative lenders that are not federally regulated, and that often come with higher interest rates.

“The expansion of alternative mortgage lending is certainly an added risk for the entire financial system,” Dunning wrote. “If it adds to risks for the broader economy, then OSFI’s B-20 Guideline indirectly adds to risks for the lenders that it regulates.”

It is estimated the stress tests introduced in 2016 and 2018 will have affected upwards of 200,000 Canadian families by the October 2019 election, by way of reducing their home-buying power or preventing them from purchasing altogether.

While the association’s position isn’t necessarily a complete removal of the stress tests, it does call for key changes, including:

  • Basing any stress test on a relevant interest rate that takes into consideration income growth and principal repayment;
  • Not subjecting mortgage renewals to stress tests, as long as the borrower is current on their payments;
  • Relaxing rules to make it easier for mortgage borrowers with small, alternative lenders to transfer to more liquid and lower-cost lenders.

Association Eyes 0.75% Stress Test

In an interview with the Toronto Star, Dunning said the issue isn’t the stress test itself, but how it’s being implemented.

“There is nothing wrong with stress testing mortgages,” he said.

The issue with the current stress tests is that they don’t take into account the fact a borrower’s income will likely rise about two percent annually over the period of the five-year loan.

“If you think five years from now interest rates will be two points higher and incomes will be 10 points higher, you make the stress test 0.75% [above the contracted interest rate] to replicate what will happen in five years,” he said. “That’s a defensible change they could make.”

The current stress test for uninsured mortgages (those with a 20%+ down payment) is the greater of the Bank of Canada’s five-year benchmark rate (currently 5.34%) or the borrower’s contract mortgage rate plus two percentage points.

“We’ve been asking for a reduction in the stress test for quite a while now because it does mathematically kind of accordion how much of a purchasing impact people will suffer, and certainly for those at the bottom of the property ladder,” Mortgage Professionals Canada President and CEO Paul Taylor said during a BNN appearance. “We feel a 75-basis-point stress test makes much more sense.”

Housing as an Election Issue

Housing is expected to be a key issue in the lead-up to this October’s federal election.

The first hint of that came on Tuesday, when Finance Minister Bill Morneau said during a pre-budget event that the government plans to look into ways to make homebuying more affordable for first-time buyers.

He noted the government has already tried to increase the supply of affordable housing and control runaway home prices in the country’s largest markets by introducing the stress tests.

“The middle part — the big middle part — is the affordable housing for millennials,” he said. “That’s a real challenge and there’s multiple things we’re looking at in order to think about how we can help in that regard.”