The use of Canada’s benchmark rate in administering the mortgage stress test is currently under review, according to an official with the Office of the Superintendent of Financial Institutions (OSFI).
Canadian Mortgage Trends – Steve Huebl·
Photo: James Bombales
Livabl is here to help you understand the housing market. With this comprehensive explainer, our aim is to give you a 360-view of this important issue that has been affecting the market.
For prospective homebuyers, there are several financial hoops to jump through on the way to property ownership: growing a healthy downpayment, securing a preapproval, and finding a home that fits within budget, to name a few. Yet, even with years of financial planning, the dream of homeownership can quickly come crashing down if one cannot jump through the hoop that trips up first-time and repeat buyers alike: the mortgage stress test.
In January 2018, the Office of the Superintendent of Financial Institutions, a federal watchdog and the sole regulator of Canadian banks, implemented the Residential Mortgage Underwriting Practices and Procedures guideline — otherwise known as B-20. Under B-20, all new and renewing homebuyers who opt for a regulated mortgage lender are subject to a mortgage stress test, which evaluates the borrower’s ability to afford residential mortgage payments against higher interest rates. OSFI says that this policy protects Canadian homeowners from excessive debt and unaffordable mortgage payments.
“The stress test, which is one component of our B-20 guideline, is a safety buffer that ensures a borrower does not stretch their borrowing capacity to its maximum, leaving no room to absorb unforeseen events,” says OSFI in a statement to Livabl. “Borrowers across Canada face different risks that could impair their ability to pay their mortgage: changes to income, changes to expenses, changes to interest rates.”
However, the mortgage stress test does not affect everyone equally. In Canada’s most expensive markets, such as Toronto, where the average price of a home is expected to surpass $820,000 in 2019, buyers have been disqualified for mortgages by the test based on high down payment requirements. Meanwhile, in cheaper real estate markets, such as Regina, the RBC reports real estate prices fell in the third quarter of 2018. Yet, as the job market remains stagnant in some cities, meeting the income standards to pass the stress test creates a provincial disadvantage.
“The one downside is that it’s made it harder for some buyers to get into the market because what they can spend on a home now is a lot lower than what it was a year or two ago before the stress test,” says John Pasalis, Founder and President of Toronto-based brokerage Realosophy.
In other cases, desperate buyers are opting to avoid the stress test altogether by choosing to work with private lenders, who are not federally regulated by OSFI and offer much higher interest rates. Some have questioned the financial stability of the market with this increased presence of higher interest rate lenders.
“People are going to private lenders, and that brings on other risks,” says mortgage broker Elan Weintraub. “It brings on economic risks because if people are paying $4,000 a month for a private lender mortgage payment, they can’t go to restaurants, they can’t buy clothes, they can’t spend money on other things.”
If you’re a first-time buyer, don’t stress about the stress test. We turned to mortgage and real estate professionals to help answer key questions about the test.
All Canadian buyers are required to take the mortgage stress test, but how you are tested depends on the size of your down payment.
If you have a downpayment of less than 20 percent of the home purchase price, your mortgage is automatically insured. With the added insurance premiums, your payment rates are increased up to 4 percent higher. Insured mortgages will be tested between the interest rate offered by the regulated mortgage lender — typically, one of the top five banks of Canada — against the Bank of Canada’s conventional five-year mortgage rate (5.34 percent as of February 2019).
Those with uninsured mortgages and down payments greater than 20 percent, will be have their current rate tested, plus a two percent point increase, against the five-year bank rate. To pass the stress test, the calculated interest rate must meet the Bank of Canada’s qualifying rate or the contracted rate plus two percentage points, whichever is higher. For example, if your lender offers an interest rate of 2.99 percent for your uninsured mortgage, plus two percentage points, your calculated interest rate would need to meet the Bank of Canada’s minimum qualifying rate of 5.34 percent, since it is the greater of the two.
The mortgage stress test will consider elements such as your gross income, debt and expenses. A mortgage qualifier calculator can give you an idea how much income and down payment amount you’ll need to pass, but Pasalis recommends speaking with a mortgage broker before you begin the process.
“In the past, you could just go on some mortgage calculator and try to estimate yourself,” he says. “But with stress tests and all of these new mortgage rules, you want to go to a mortgage broker for them to tell you, in theory, what you qualify for, because that kind of really sets your expectation of what you can afford to spend on a home.”
If you wish to secure a fixed-rate mortgage, the stress test may dash those hopes.
Fixed-rate mortgages are typically priced higher than variable-rate mortgages, as variable-rate payments fluctuate with interest rates and a higher proportion of a mortgage payment goes to principal. These higher fixed-rates can limit your options when applied to the stress test. As Weintraub describes, borrowers looking at a fixed-rate of 3.69 percent with an uninsured mortgage, plus two percentage points, wouldn’t qualify against the Bank of Canada’s rate.
“There are some clients who are so tight they can’t have a 5.69 [percent] stress test, they need a 5.34 [percent] stress test, so they have to get the variable rate even if they want fixed,” says Weintraub. “If you make a lot of money you can have both options, but if you have a very tight file, you might only have the option of variable.”
A common criticism of the stress test is its tendency to trap borrowers with their current lenders. Buyers who purchased their home prior to the stress test are still required to participate. For those who won’t pass, it means staying with the same mortgage lender to avoid disqualification.
“Imagine that you want to renew your mortgage but you technically don’t qualify under the new stress test. You’re technically handcuffed with that same lender,” says Pasalis. “They can charge you eight percent interest and you can’t do anything about it.”
While OSFI ensures that the stress test, “contributes to public confidence in the Canadian financial system,” Weintraub questions whether this element of the policy benefits the market overall.
“If the bank knows the borrower cannot leave, how competitive are they going to be with their rates?” he says. “Some of my lowest interest rates are when their mortgage is expiring and I can move them to a new lender. But if they don’t pass the stress test, they’re basically forced to stay with their current lender, which doesn’t make sense.”
If you’re a nervous test taker and want to sit out, then you do have the choice to not take the stress test — but at a cost.
The mortgage stress test does not apply to unregulated mortgage finances companies, called MFCs. While provincially regulated, these lenders operate in the private market, which makes loan approvals easier to obtain, but at higher rates. Weintraub suggests that an MFC lender should be reserved for short-term loan options.
“If you’re a first time buyer dying to buy a place and you go to a private lender, I don’t necessarily know if that’s the right solution,” says Weintraub. “I think private lenders are meant for very short term solutions, to help someone in a very specific situation, and then to get out of that situation ideally in 12 months or less.”
Pasalis says that MFCs tend to take on riskier borrowers, so higher interest rates compensate for that liability. But these higher payments, Weintraub says, can push new buyers into being house poor.
“It’s meant to be a stop gap, it’s not meant to be a long-term, sustainable way to borrow money, because it’s very expensive,” he says.
Flunking the stress test is not the end — you can always retry later with a higher down payment or increased income. Weintraub says that the Bank of Mom and Dad could be available for some buyers looking for a mortgage co-signer or a boost in down payment funds. However, he recommends evaluating whether homeownership is truly worth it if this is the case.
“I would say that buying is not for everyone and sometimes we get into this whole, ‘I need to buy, I need to buy,’ mentality,” says Weintraub. “But there are certain situations where renting is a great option.”
While there has been increasing pressure for OSFI to provide policy relief for those in expensive markets, they remain firm on preventing “relaxed mortgage underwriting standards.” Pasalis says that there is always future potential for first-time buyer relief, but overall, exceptions to a national policy are unlikely to be made for individual market conditions.
“They can’t craft out different policies for Vancouver and Toronto and by municipalities,” he says. “I think the market will adjust to it.”
Source: Livabl.com – Michelle McNally
Those are among the findings of Mortgage Professionals Canada’s newly released Report on the Housing and Mortgage Market in Canada.
“…the cumulative impact of rising rates, a 2% or greater stress test, provincial government rules in Ontario and British Columbia, and further lending restrictions are negatively suppressing housing activity, not just in Toronto and Vancouver, but throughout the country,” said Paul Taylor, President and CEO of Mortgage Professionals Canada.
Will Dunning, the report’s author and the association’s chief economist, added that aside from the new mortgage lending policies “unduly suppressing” housing activity, consumers are now taking a materially more negative outlook towards housing.
“Our consumer survey has found that sentiment regarding the housing market has shifted decisively downwards during the past year and a half, reflecting the impacts of increased interest rates and government policies that are making it more difficult for potential homebuyers to obtain the mortgage financing they need,” he wrote.
While an increasing number of first-time buyers are receiving down payment assistance from their parents, many young people are adapting to the idea that they may never own a home and will become permanent renters.
The following are highlights from the report:
New OSFI Regulations
Housing Market Trends
Economic Impact of Slowing Housing Activity
Sources of Down Payments – Family to the Rescue
Reasons Against Owning
Source: Canadian Mortgage Trends –
Crazy high prices are no longer the only thing keeping prospective buyers in B.C. from jumping into the real estate market or trading up for bigger or better pads.
As of Monday, all borrowers will need to pass a stress test before they are allowed to take out mortgages from federally regulated institutions such as banks, regardless of how large their downpayment. People who fail the test won’t be able to buy, and estimates have put the ratio of those who will flunk as high as one-in-five.
What is a stress test?
It’s all about subjecting prospective home purchases to a “What if?” scenario. Specifically, what would be the shape of a given buyer’s finances if interest rates were to suddenly spike.
The concept is relatively new. Insured mortgages in Canada were already subjected to such tests, but they now apply to uninsured mortgages as well, explained Samantha Gale, the CEO of the Mortgage Brokers Association of B.C.
How high is the bar?
Potential buyers will be tested against the greater of either the Bank of Canada’s five-year benchmark rate (now 4.99 per cent) or the rate offered by a lender plus another two per cent.
“For example, if they were to get a mortgage with an interest rate of three per cent, they now need to qualify to show that they can afford five per cent,” Gale explained.
What if the bar is too high?
Those who fail the test will need to look for something cheaper on the market.
“If you were to buy a home worth $700,000 last year, this year you might only be able to afford a home worth $560,000. That’s quite a big discrepancy,” Gale said, adding that it is probably more important than ever to speak to a mortgage broker to see what the options are.
Why put buyers to a test?
The federal government is concerned about Canadians’ debt levels, Gale said. Because it has the tools to regulate banks, it is easy for Ottawa to impose mortgage rules rather than rules on other forms of borrowing, she said.
Gale said she did not believe a housing crash like that experienced in the U.S. a decade ago is in the cards. “Generally speaking, people want to stay in their home. They find a way to pay their bills, to pay their mortgage,” she said.
Do the new rules affect you?
Quite possibly. If you are buying and need to borrow from a bank, they will, and they will also apply to anyone looking to refinance.
While those seeking to renew mortgages under existing terms will not need to re-qualify and be stress tested, those shopping around for a better rate will. “One of the challenges might be that a certain lender might not offer a competitive rate at renewal time, knowing that buyers can’t really shop around,” Gale said.
Today, the Office of the Superintendent of Financial Institutions (OSFI) introduced new rules on mortgage lending to take effect next year.
OSFI is setting a new minimum qualifying rate, or “stress test,” for uninsured mortgages (mortgage consumers with down payments 20% or greater than their home price).
The rules now require the minimum qualifying rate for uninsured mortgages to be the greater of the five-year benchmark rate published by the Bank of Canada (presently 4.89%) or 200 basis points above the mortgage holder’s contractual mortgage rate. “The main effect will be felt by first-time buyers,” says James Laird, co-founder of Ratehub.ca. “No matter how much money they put down as a down payment, they will have to pass the stress test.” The effect of the changes will be huge, resulting in a 20% decrease in affordability, meaning a first-time homebuyer will be able to buy 20% less house, explains Laird.
MoneySense asked Ratehub.ca to run the numbers on two likely scenarios and find out what it would mean for a family’s bottom line. Here’s what they found:
In this case, the family’s mortgage rate, plus 200 basis points, is less than the Bank of Canada five-year benchmark of 4.89%.
According to Ratehub.ca’s mortgage affordability calculator, a family with an annual income of $100,000 with a 20% down payment at a five-year fixed mortgage rate of 2.83% amortized over 25 years can currently afford a home worth $726,939.
Under new rules, they need to qualify at 4.89%
They can now afford $570,970
A difference of $155,969 (less 21.45%)
In this case, the family’s mortgage rate, plus 200 basis points, is greater than the Bank of Canada five-year benchmark of 4.89%.
According to Ratehub.ca’s mortgage affordability calculator, a family with an annual income of $100,000 with a 20% down payment at a five-year fixed mortgage rate of 3.09% amortized over 25 years can currently afford a home worth $706,692.
Under new rules, they need to qualify at 5.09%
They can now afford $559,896
A difference of $146,796 (less 20.77%)
If a first-time homebuyer doesn’t pass the new stress test, they have three options, says Laird. “They can either put down more money on their down payment to pass the stress test, they can decide not to purchase the home, or they can add a co-signer onto the loan that has income as well,” says Laird. The stress test will be done at the time of refinancing as well, with one exception. “If on renewal you stay with your existing lender, then you don’t have to pass the stress test again,” says Laird. “However, if you change lenders at mortgage renewal time, you may have to pass the stress test but it’s not crystal clear now if this will be the case for those switching mortgage lenders.”
So if you’re a first-time homebuyer, it may mean renting a little longer and waiting for your income to go up before you’re able to buy your first home. Alternatively, some first-time buyers will buy less—maybe a condo instead of a pricier detached home. Or, the new buyers may opt to get a co-signer to qualify under the new rules.
But whatever you do, if you’re a first-time buyer, make sure you understand what you qualify for using the new regulatory rules, and get a pre-approved mortgage before you start house-hunting. “This shouldn’t be something that shocks you partway through the home-buying process,” says Laird.
And finally, do your own research and run the numbers on your own family’s income numbers. You can use Ratehub.ca’s free online mortgage affordability calculator to calculate the impact of the mortgage stress test on your home affordability.
Source; MoneySense.ca – by Julie Cazzin