Is the new mortgage stress test doing more harm than good?
A method designed to help keep Canadian homeowners on the right track financially with their mortgages may actually be doing more harm than good.
Introduced in late 2017 and officially implemented in January 2018 by Office of the Superintendent of Financial Institutions (OSFI), the new “mortgage stress test,” also known as the B-20 mortgage rule, saw changes made to the rules for mortgages in Canada. It evaluates homeowners’ ability to prove that they can handle an uninsured mortgage while dealing with rising interest rates.
More specifically, the changes involve a new minimum qualifying rate for all uninsured mortgages. The rate must be greater than the standard five-year rate set by the Bank of Canada, plus 2 per cent. As a result, lenders are being forced to change their loan-to-value (LTV) ratios as a response added risk in the ever-changing economic climate and housing market.
The new mortgage stress test also places limitations on mortgage loans that elude or appear to elude LTV constraints. Under the new rules, financial institutions cannot arrange a mortgage or any derivative products through a third-party lender that would seemingly or wilfully circumvent the institution’s highest LTV ratios.
It’s expected that these changes will certainly have an impact on borrowers and lenders alike. But of the two rules, more people are expected to focus on the new qualifying rate.
The stress test’s effects on the housing market
The mortgage stress test and its rules have only been place for just over a year, and already their effects are being felt by homebuyers and the real estate market as a whole. A report from the Financial Post indicates that rapidly falling home sales in the greater Vancouver area during March were a direct result of the mortgage stress test.
Statistics from the Real Estate Board of Greater Vancouver show that a record-low 1,727 homes were sold in April 2019, representing a 31.4 per cent drop year-over-year. Home sales in March 2019 increased by 16 per cent, but the board stated in a release that sales were still over 46 per cent lower than the 10-year March average, the lowest recorded average in more than 30 years.
New taxes and the implementation of the mortgage stress test are primarily to blame, and both have forced Vancouver’s housing market off the rails. Prior to the rule changes, home sales, economic growth and low unemployment rates were in sync with the city’s housing market.
The performance of Vancouver’s housing market is just one example of how the stress test is affecting one segment of Canada’s housing market. Data from the Canadian Real Estate Association (CREA) shows that March 2019 home sales in Canada were down by 4.6 per cent compared to 2018 results. Average home sale prices were also on the decline, falling 1.8 per cent year-over-year to $481,745.
The stress test’s effect on mortgages
The new mortgage stress test’s effects on the housing market also had a direct impact on mortgages themselves. According to a report from CIBC World Markets deputy chief economist Benjamin Tal, the total value of new mortgages in 2018 dropped 8 by per cent, a difference of $25 billion. By Tal’s estimate, the stress test account for between $13 billion and $15 billion, or up to 60 per cent of the total value.
Tal believed the new rules were necessary when originally introduced, but now acknowledges that they need to allow for more flexibility. One of the main issues with the stress test is that the rules are very rigid; they do not consider increases to homeowners’ incomes, nor do they have a way of dealing with interest rate increases. Also not factored into to the stress test: those who opt for risk-reducing longer mortgage terms and those who pay back a good chunk of their principal during their term.
How alternative lenders are cashing in
While negatively impacting the housing and home resale markets, the stress test has been a boon for alternative lending institutions, which are not bound to as many regulations as traditional lenders are. According to Tal’s report, while alternative lenders certainly have a place in today’s market, a rapidly growing alternative lending scene does not due to the lack of regulation surrounding it.
Alternative lending sources were not factored into the stress test, and borrowers only tend to approach them when they have bad credit or are turned down by major banks. Given that the stress test forces borrowers to prove they can take on an uninsured mortgage rate while coping with increasing interest rates, those unable to do so were forced to seek another route and flocked to alternative lenders as a result.
A possible solution to the new mortgage stress test
In his report, Tal suggested that the government revise the rules of the stress test be amended to include more flexibility. He discussed the notion of setting some standards, such as the establishment of a floor under which qualifying rates would never drop below. If approved, these amendments would certainly decrease the rigidity of the test and ultimately help the housing and mortgage markets to return to normal.