Canada’s Mortgage Stress Test Good in Theory, But Should Be Better in Practice
Several months ago, before the onset of COVID-19, the federal government announced changes to the mortgage stress test. Those changes, once expected to take place on April 6, have now been pushed back indefinitely.
But even if and when those changes do arrive, some in the business don’t believe they’ll make much of a difference for the average homebuyer.
“Don’t get me wrong, having a stress test is a good idea,” says Jerome Trail, owner and broker of record at The Mortgage Trail. “We definitely want people to be qualified. But the current benchmark doesn’t make sense.”
The benchmark Trail is referring to is the current test published by the Bank of Canada that’s based off of the posted five-year conventional mortgage rates that are offered by the country’s biggest banks. So, for instance, on May 19, that rate was 5.04%.
“The test should be in line with what’s actually happening in the industry,” Trail says. “You can get 5-year fixed rates under 3% and 10-year fixed rates under 4%. Again, a stress test is important, but why can’t it be a five-year fixed rate plus one per cent, or why isn’t the 10-year fixed simply the test? 10 years seems like a good indication of the confidence the professional economists have in their lending.”
The new benchmark for the tests will be a weekly, five-year rate calculated by the Bank of Canada and based on mortgage insurance applications using actual rates a variety of lenders are currently offering homebuyers, plus another two percentage points. So, when the new rules are introduced, if the current five-year fixed rate many lenders are able to secure is somewhere around 2.89% then adding two points would bring the new mortgage stress test down to 4.89% (rather than the aforementioned 5.04% rate on May 19).
But that 0.15% simply doesn’t equate to being a big enough game changer for the average homebuyer.
The average home prices across the GTA for the month of April were $821,392 ($881,424 in Toronto proper, $789,317 in the ‘905’) according to TRREB, the difference between the Bank of Canada’s conventional mortgage 5-year rate of 5.04% and, say, the possible new stress test measure of 4.89% is less than $10,000 in maximum affordability for a first time homebuyer making $100,000 annually.
Even with the new stress test coming in to effect, the household income for first-time homebuyers in Toronto would have to be north of $175,000 to begin qualifying for the averaged price home in the city. What’s more, these first timers would need nearly $200,000 in cash to secure their new home and be carrying little or no other debt in order to qualify.
Drop the mortgage stress test down to a 10-year fixed rate – lenders are offering anywhere between 3.25 and 4% right now – and the household income necessary to qualify for the average home in Toronto drops by $30,000+ per year. That makes it a lot more accessible for first-time homebuyers to get into the market, and does so at a rate that’s long enough to suggest security.
The stress test has been used to ensure that homeowners can afford their mortgage payments if interest rates rise in the future. But it has been criticized since its introduction for being too high and based only on the big banks’ posted rates, compared to the actual mortgage rates offered by a variety of lenders.
In fact, a recent survey on home buying and selling intentions commissioned by TRREB found that 65% of respondents support relaxation of the federal mortgage “stress test.”
“In 1997, I signed a 5-year fixed rate at 6.1% on my first house with one of the big banks and when I called my dad to tell him he said, ‘6.1%? You’re the luckiest guy on the planet,'” says Trail. But times change, and the industry adapts. Now, no one would consider 6.1% anything other than a joke. “We’ve not had interest rates in that range in the near- or long-term in a long, long time,” adds Trail.
Maybe it’s time the industry starts acting like it.