Getting a mortgage can be tough, especially with the price of houses these days. But over the past year-and-a-half or so, borrowers have had an even tougher time securing a mortgage all thanks to the “mortgage stress test.”
To pass the test, anyone who wants to apply for a mortgage must prove that they’ll be able to continue making their mortgage payments even if rates increase at some point in the near future.
What is the Mortgage Stress Test?
In the past borrowers with a 20 per cent down payment weren’t required to take a mortgage stress test. But, as of January 2018, the rule was changed to include all mortgage applicants regardless of the size of their downpayment.
The actual test itself requires that mortgage applicants be able to prove that they can make their mortgage payments at their qualifying interest rate plus two percentage points or the Bank of Canada’s five-year benchmark rate, whichever of the two is greater.
At the time of publishing, the Bank of Canada’s five-year benchmark rate sits at 5.34 per cent. If, for instance, you were to take out a mortgage at 3.75 per cent, you would have to be able to prove that you can handle a mortgage at 5.75 per cent (your rate of 3.75 per cent + 2 per cent), since this amount is greater than the benchmark rate.
What is the Purpose of This Stress Test?
Borrowers who default on their mortgage payments risk losing their homes. They also put lenders in a precarious position to have to scramble to recoup their investment if they have a borrower on their hands who isn’t paying them back for the loan offered.
To combat this situation, lenders put mortgage applicants through a stress test to make sure they’ll be able to continue making their payments even if rates increase over the life of their loan. While borrowers might be OK making payments with a 3.5 per cent interest rate, for instance, how would they be able to deal with their mortgage if rates hike up to 5 per cent or beyond?
By putting borrowers through the stress test, lenders will be able to verify if applicants have the financial strength to cover their mortgage payments, even if their interest rate increases. In turn, the hope is that the odds of mortgage default will decrease.
The mortgage stress test rules also changed in an effort to cool the housing market. As we’ve seen, prices of homes have skyrocketed over the past few years, pushing many homebuyer hopefuls out of the market and increasing the size of the housing bubble.
In an effort to prevent this bubble from bursting, mortgage criteria have become increasingly stringent to essentially put a cap on how much people are able to spend on a home.
Is the Stress Test Too Much?
Proponents of the mortgage stress test would argue that having the test in place is a positive thing for the housing market. Making sure that lenders are being prudent about who they hand out mortgages to can help keep a lid on mortgage defaults and can help better manage consumer buying power.
Making sure that people are actually financially capable of affording their mortgages without maxing out their finances seems like the responsible thing to do. Or else, we could end up being immersed in a catastrophic housing crash like we saw the US go through a decade ago.
But opponents would say that such stringent tests make it extremely difficult for the average mortgage applicant to secure a home loan. In fact, a recent report has found that the new stricter mortgage rules are leaving 18 per cent of buyers out of the real estate market.
While the government might want to cool the market, such rules could potentially slow it down too much. And with mortgages becoming too tough to get approved for, many consumers who would otherwise have bought a home may end up renting for a lot longer. And with increased demand for rent typically comes higher rent prices.
Only time will tell how the new mortgage stress test rules will play out on the real estate market in Toronto — and across the nation — into 2019 and beyond.