Why the mortgage stress test is likely here to stay despite high rates

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Millicent Wong
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Regulators will announce a stress test review on December 15

Sale sign in front of houses The interest rate at which borrowers must qualify for a mortgage has risen to eight percent. Photo by Derek Baldwin /Belleville Intelligencer/Postmedia Network

The Bank of Canada’s interest rate hike last week pushed the qualifying interest rate in Canada’s mortgage stress test above 8 percent for many borrowers, raising questions about whether the test is too harsh.

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The concerns come as regulators prepare to announce a December 15 stress test review. On Friday, the Office of the Superintendent of Financial Institutions (OSFI), Canada’s top banking regulator, poured cold water on calls for a formula change amid soaring interest rates, which have risen 400 basis points so far this year,

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“We see great risk in speculating on the mortgage rate cycle and we do not view the interest rate floor as a tool to manage housing demand,” OSFI Superintendent Peter Routledge said in a statement. “We view the qualifying minimum interest rate as an underwriting practice that adds an important safety buffer to residential mortgage portfolios, the largest risk Canadian lenders have on their books.”

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In 2018, the Canadian government introduced the mortgage stress test. Since then, state-regulated lenders have been forced to ensure borrowers can still make payments at a rate two percentage points above the contract rate being offered.

With major banks now offering a prime lending rate of 6.45 percent following the Bank of Canada’s recent rate hike, the qualifying rate for many mortgages will exceed 8 percent.

True North Mortgage chief executive Dan Eisner said that since Wednesday’s rate hike, a homebuyer needs to make about $200,000 a year to afford a $1 million home.

“A typical customer has $10,000 in credit card debt and a car payment, so to buy this house with a 20 percent down payment you need to make about $200,000 a year … assuming you have other debt,” said Eisner in an interview.

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Average house prices in Toronto and Vancouver both cross the million-dollar mark, while the national median house price was $644,643 in October, according to the Canadian Real Estate Association.

While OSFI focuses on protecting loan portfolios, the stress test provides borrowers with a buffer in the event that interest rates rise or their personal financial situation changes, e.g. B. through job loss or drop in income. It also ensures that borrowers have some protection from other changes in the economy, such as B. recessions or rising cost of living. All of these issues are currently in play.

Even before Routledge’s statement was released on Friday, most mortgage industry professionals suspected that OSFI planned to keep things the same when it announced its review this week.

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“I would say that the stress test is proving its worth,” Robert Hogue, deputy chief economist at the Royal Bank of Canada, said in an interview last week. “It was designed primarily to protect us from what we have seen since March – a sharp rise in interest rates – and to ensure that the vast majority of borrowers are able to handle the rise and not get into trouble devices. This is a very important back-up tool to have in the policy maker’s toolbox.”

While Hogue said an argument could be made to loosen the buffer as the likelihood of rates rising another two percentage points has decreased, he said there was still too much uncertainty about the trajectory of the economy.

“I suspect OSFI will leave things as they are,” he said.

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Bank of Montreal economist Robert Kavcic said he sympathizes with borrowers.

“Basically, the point here is that the stress test was really designed to work in an exceptionally low interest rate environment, assuming that this period was not normal,” Kavcic said in an interview. “Now that we’re back to more normal times, I can sympathize with the question, ‘Do we still need to qualify people who are 200 basis points above today’s rates?’ ”

While Kavcic sees areas for improvement on the MQR, he believes it may not be the right time for OSFI to make changes.

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“On the other hand, is now really the best time to make changes as we may be entering an economic slowdown?” Kavcic said. “Maybe interest rates will peak, but we could also face an income shock in the next year or so if the economy goes into recession.”

Karen Yolevski, chief operating officer of Royal LePage Real Estate Services Ltd., doesn’t think OSFI will make changes to the MQR simply because regulators firmly believe in the purpose of the test, which is to ensure borrowers can keep up with their mortgages.

“The purpose of the test has been well established since its inception, and I don’t think that reasoning has changed for regulators,” Yolevski said in an interview. “Because of that, I don’t think they’re going to make a change now.”

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