Good news is on the way for those getting into the housing market this spring – it’s going to become a bit easier to qualify for a mortgage, as changes are in store for the much-contested federal mortgage stress test.
The Department of Finance announced on February 18 that it will be tweaking the qualification criteria used in the stress test, to go into effect on April 6 – just in time for the busiest housing market season of the year. Under the new changes, the benchmark rate – also referred to as the “floor” – used to set the stress test threshold for borrowers will be changed from the five-year rate set by the Bank of Canada (which in turn is set by an average of the posted five-year rates offered by the Big Six banks) to the weekly five-year median insured mortgage rate used in mortgage insurance applications, plus 2%.
Currently, the change is only for insured mortgage borrowers – those who pay less than 20% down on their home purchase and require mortgage default insurance from the Canada Mortgage and Housing Corporation. However, the same change is likely to come for uninsured mortgages too, according to national banking regulator the Office of the Superintendent of Financial Institutions, which will be consulting on the matter until mid-March. The stress test has been in place for insured borrowers since October 2016, while the version for uninsured mortgages rolled out in January 2018.
What Does This Mean for Home Affordability?
This change is notable as it will materially reduce the threshold these borrowers need to qualify at in order to obtain home financing, as the rates offered by lenders for insured mortgages are typically much lower than the posted rates at the big banks; for example, the current BoC rate sits at 5.19%, while many lenders offer insured mortgage rates today below 3%. In fact, if the new median rate was made available now, it would sit at 4.89%.
According to calculations from RateHub, a borrower getting a mortgage rate of 2.89% and tested at the new rate would qualify for a home valued at $526,632, $15,000 more than the $511,424 they’d receive under the current rate.
Why is the Stress Test Changing?
Mortgage industry experts have criticized the gap between the stress test and actual mortgage rates as being out of touch with real-time markets, with the difference growing ever larger in today’s low-interest-rate environment. As a result, Finance Minister Bill Morneau was instructed by the government to review the stress test late last year to ensure it was better aligned with real market conditions.
However, tweaking its criteria required a sensitive approach, as it was put in place to protect borrowers’ ability to pay their mortgage should rates rise, and prevent them from taking on too large of a loan in the first place.
In its announcement, the Department of Finance said that while the measures have largely achieved these goals, “This adjustment to the stress test will allow it to be more representative of the mortgage rates offered by lenders and more responsive to market conditions.”
Stated Morneau, “For many middle-class Canadians, their home is the most important investment they will make in their lifetime. Our government has a responsibility to ensure that investment is protected and to support a stable housing market. The government will continue to monitor the housing market and make changes as appropriate.”
Real Estate Industry Voices Support for Change
The reaction from realtors at the national level has been positive, as the stress test has been blamed for reducing affordability for many buyers and cooling the market. According to the Canadian Real Estate Association, per capita sales activity in 2018 reached its lowest point since 2001 following the uninsured stress test, while 2019 final sales tied for second-worst.
While calmer buying activity may have been welcome in Canada’s most expensive housing centres, such as in the Vancouver and Toronto real estate markets, there was criticism that the measures disproportionately affected smaller cities where conditions were balanced, or already in buyers’ market territory, like the Prairies. As well, there was growing concern that borrowers shut out by the test moved instead to B and alternative lenders to get their home financing, which actually added more risk to the borrowing landscape due to their higher interest rates and overall less favourable terms.
Stated CREA President Jason Stephen, “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.”
Will This Add More Fuel to Already Heating Markets?
Not everyone is hailing the change to the stress test to be a positive development, expressing concern it will only contribute to rapidly heating prices and buyer competition in the nation’s largest cities, which have gotten an early start this year; the Toronto Regional Real Estate Board is reporting that average GTA prices approached the $900,000-mark in January, having increased 12.3% year over year. From a national perspective, CREA said the sales-to-to-new-listings ratio for Canada as a whole was 65.1% in December – well over the threshold to be considered a sellers’ market.
According to Capital Economics’ Senior Canada Economist Stephen Brown to the Financial Post, “The timing could hardly be worse.”
“Reducing the severity of the stress test is likely to put further upward pressure on housing prices, at a time when the sales-to-new-listings ratio already points to a surge in house price inflation ahead,” he stated. “The dilemma the Bank currently faces, between the need to support activity on the one hand and the need to limit the build-up of financial risks on the other, will only get worse.”
It remains to be seen how this latest change will filter through the housing market, especially with competitive urban centres already experiencing hot conditions in the typically slower late-winter season. All eyes will be on whether the mortgage industry experiences a significant uptick in applications once the easier rate is in force.