The Department of Finance created shockwaves this week with its announcement that it will be revamping how insured mortgages are stress tested.
Now that the dust has settled, here’s a more in-depth look at the implications, as well as some industry reaction.
But first, a quick recap of what’s changing come April 6, 2020:
Current stress test rate for insured mortgages (typically those with less than 20% equity): 5.19%
Based on the Big 6 banks’ posted 5-year fixed rates.
New stress test rate (if it were in effect today): ~4.89%
Based on a rate equal to the weekly median 5-year fixed insured mortgage rate plus 2%.
Could the new benchmark rate eventually be higher than the current qualification rate?
According to estimates from Mortgage Professionals Canada’s chief economist Will Dunning, yes.
He plotted his estimate of the typical “special offer” rate advertised by major lenders, and as recently as late-2018, the new qualifying rate would have been nearly 40 basis points higher than the new qualifying rate. Dunning notes, however, that it would be beneficial to have official data provided directly from the Canada Mortgage and Housing Corporation (CMHC) to remove some of the guess work from estimating the official average insured mortgage rate.
“Given the history, it’s highly possible that there will be future times when the new qualifying rate will be higher than the posted rate, but I don’t see that as important: the posted rate should never have been part of the mortgage stress tests,” Dunning told CMT.
How will the rate be calculated, exactly?
That’s still to be determined, at least publicly. The Bank of Canada says it can’t confirm if the new benchmark rate will be based on all insured applications (such as 2- to 4-unit properties, self-employed borrowers, second homes, rental properties, etc.) or just a core group.
How much of the mortgage market will be impacted by the stress test rate change?
As of 2018, insured mortgages accounted for less than a third of new mortgages. Although, the Office of the Superintendent of Financial Institutions (OSFI) announced it is also considering a similar change in its formula for stress testing uninsured mortgages (those with more than 20% equity). OSFI is currently accepting input from stakeholders by email until March 17, 2020.
How much does it help the average buyer?
There’s no question the new formula for stress testing insured mortgages will help many buyers who are currently just on the cusp of being able to pass the stress test.
Consider that the current stress test rate of 5.19% is a full 283 basis points higher than the lowest available insured mortgage rate on the market.
The new formula will narrow that gap by 30 basis points after April 6. This will decrease the income required to buy a $300,000 home by roughly $1,500, assuming a 5% down payment and 25-year amortization.
Alternatively, it will allow those who can easily pass the stress test to purchase about 5% more home. As Ron Butler of Butler Mortgage Inc. told us, “Someone who qualified for a $500K mortgage (previously) will qualify for $525K in April.”
Does the move go far enough to help buyers?
It depends on who you ask. Industry representatives say the changes are welcome, but that there’s still room for improvement to assist young and aspiring homeowners struggling to enter the housing market.
“A stress test at 4.89% is better than one at 5.19%, but this test threshold is still too high, for several reasons,” MPC’s Chief Economist Will Dunning told CMT.
“Most importantly, the tests fail to acknowledge that by the time of a renewal in five years, the borrower’s income will have increased, usually by more than 10%, and they will have more capacity to make payments. The calculations should, but don’t, take this into consideration.”
Dunning adds that after a five-year term of the borrower faithfully making payments, the outstanding principal will have been reduced by 14-15%. “The design of the test doesn’t properly account for this, and therefore it over-estimates how much the payments would increase. And, it increasingly looks unlikely that rates will rise by anywhere near the 2 percentage points that the revised test will assume.”
Paul Taylor, President and CEO, Mortgage Professionals Canada, told BNN Bloomberg that he’s not sure if the change will help qualify a “tremendous” number of additional buyers.
“It certainly will help some folks on the margin,” he said. “But it’s certainly good news for the marketplace from a policy perspective.”
Taylor added the association would like to see the test closer to 75 basis points above a buyer’s contract rate (as opposed to 200 bps) based on calculations that take into account income growth and mortgage principal payment over the term of the mortgage.
Responding to concerns of the change contributing to increased home prices, Taylor said this: “I think the lack of supply is really what is causing the increase in those prices. There are just far more people than there are housing products available for them. This particular change…is not really going to affect the prices in isolation. I think it’s the rest of the dynamics in the market that are going to create the increases that everybody is expecting.”
Industry Reaction to the Stress Test Change
Here’s a selection of other viewpoints from across the industry on the stress test rate change:
Jason Stephen, President of The Canadian Real Estate Association (CREA)
“REALTORS have advocated for changes to the stress test on behalf of potential homeowners who have been sidelined, borrowers who have moved away from the regulated market to less-regulated options, and real estate markets across the country in need of relief. We are pleased the government has taken steps to address some of these issues in Canadian housing markets.”
Evan Siddall, head of the Canada Mortgage and Housing Corporation (CMHC):
“It’s worth noting that by changing the reference rate, authorities are recommitting to the merits of the stress test. The credibility of the measure is strengthened via this technical improvement. Calls to reduce the margin (from 200 to 75 bps) do not have traction at present.”
Rob McLister, Founder of RateSpy.com
“Will a looser stress test stoke the market? Absolutely. While it might boost buying power by just 3% or less (depending on what the new benchmark turns out to be, come April 6), the psychological boost will be material. Homebuyers—particularly younger buyers—are already worried about prices running away from them, given the double-digit gains of the last 12 months. News of an easier mortgage stress test won’t help.”
Doug Porter, Chief Economist, BMO Bank
Extending similar qualifying rate changes to uninsured mortgage stress testing could “put further upward pressure on prices, especially in markets that are already leaning to a sellers market.”
Bill Morneau, Minister of Finance (responsible for the latest qualifying rate change)
“We think these are positive moves to ensure that the approach remains effective for Canadians and that it also deals with changing market conditions…I think what’s important for us to ensure is that we continue to protect people’s most important investment. This will ensure that people only take on mortgages that are appropriate for their situation.”
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