As mortgage costs have steadily increased over the last six months -- and with more rate pain assured when the Bank of Canada makes its next announcement on October 26 -- is it time to revisit the stress test?
These days, borrowers are facing the priciest home financing in years; five-year variable-rate mortgages, which are directly impacted by the BoC’s hiking cycle, have rocketed to the 5 - 6% range, according to the posted offerings from Canada’s big banks.
Fixed mortgage rates, while spared the volatility of monetary policy changes, have also surged as of late, as recession fears drive up the bond market. Five-year government yields have sat firmly above 3% since mid-August and hit 3.5% this past week -- nearly the high seen in June. As a result, borrowers looking to lock in will also need to pay between 5.4 - 6% interest for the privilege.
READ: Does the Stress Test Still Make Sense… And Has It Ever?
Given new mortgage applicants must prove they can carry their home loan at their contract rate plus 2%, or at the regulator’s Minimum Qualifying Rate of 5.25% -- whichever is higher -- they’re now facing a stress test between 7 - 8%. And that’s only going to get steeper: with new economist calls for a BoC terminal rate of 4.5%, borrowers could be facing a Prime rate of 6.7% by next year -- and a stress test of upwards of 9%.
This has brought fresh scrutiny for its criteria; critics point out the MQR has been largely useless since July, when the BoC hiked its rate by 1%, pulling all mortgage rates above the 3.25% range. That means all borrowers are now tested at their contract rate plus 2%, which has drawn calls for the MQR to either be raised to a level that’s relevant to the current cost of borrowing, or reduce the required 2% tack-on... or perhaps another, more creative solution.
“The Office of the Superintendent of Financial Institutions (OSFI) should weigh in on whether the current stress test remains applicable,” stated Toronto Regional Real Estate Board CEO John DiMichele, in the board’s September data release.
“Is it reasonable to test home buyers at two percentage points above the current elevated rates, or should a more flexible test be applied that follows the interest rate cycle? In addition, OSFI should consider removing the stress test for existing mortgage holders who want to shop for the best possible rate at renewal rather than forcing them to stay with their existing lender to avoid the stress test. This is especially the case when no additional funds are being requested.”
However, it doesn’t appear the regulator is feeling any urgency to do so. In fact, its top executive has made it clear a tweak won’t be in the cards this year.
In comments made to a Toronto audience in early September, OSFI Superintendent Peter Routledge stated that while, “The uncertainty and anxiety caused by a rising interest rate environment have, understandably, caused some Canadians to advocate for a loosening of the underwriting standards in Guideline B-20… “Let me reassure those of you who oppose a loosening of underwriting standards that OSFI will not do that.”
OSFI conducts an annual review of the stress test criteria, confirming its MQR each December. The regulator did tighten borrowing requirements in June for real estate secured lending products (RESL), which mainly impacts HELOCs -- but the MQR was left off the docket, leaving many in the industry scratching their heads.
Jerome Trail, broker at The Mortgage Trail, tells STOREYS that based on the average mortgage size at his brokerage, the most recent Bank of Canada rate hike, combined with the stress test criteria, has reduced buyers’ affordability by 13%.
However, he says, the stress test has proven itself to be a critical failsafe, given how drastically mortgage carrying costs have changed in the last year.
“First, we will only know in hindsight whether the stress test was good or bad. As of right now, there’s no one who can deny it -- it’s ‘thank god’ we have it,” he says. “Two, well how high is this sucker going to go? We really don’t know. And three, well, how come there’s not more discussion on what other options can exist? How else can we mitigate these headaches?”
What Trail would like to see is dialogue on how to ease other parts of the mortgage qualification, such as extending amortizations to 35 - 40 years. The best bet for today’s borrower, though, is to explore their options beyond what their big bank is offering.
“If they were to open the discussion and say, ‘As opposed to 2%, what if we look at 1%?,’ is that really going to move the needle that much? Not really,” he says. “And also, we still have options; we’ve got alternative lenders that are offering 35-year [amortizations], we still have credit unions that can use the contract rate or they’re using contract plus one. So there are other options for lenders.”
In fact, he adds, in today’s marketplace, it’s the B-side lenders who have the flexibility to loosen qualification criteria who have made deals impacted by shifting rate changes still viable -- and that’s not likely to change any time soon in this rate environment.
“The entire alternative lending sector and segment have been benefiting from what’s going on,” he says. “Who has saved our deals, a couple of problematic issues -- it’s the lender that’s been fluid and have come up with an entrepreneurial or unorthodox solution.”
