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Has the Mortgage Stress Test Done More Harm Than Good?

Some have called the moderate slowdown in housing sales across Canada a “deep freeze” however, that term may perhaps be a tad bit harsh…this isn’t 2008 after all. An article written in the February 21st issue of the Financial Post suggest that the Canadian housing market is experiencing said “freeze” and while one can debate between the language used, the cause they gave for using such semantics is far more interesting.

The article states the cause for this deep down tick in housing sales across the country, a result of the new mortgage stress test the government of Canada introduced in January 2018. It should be taken into account that the authors based their findings on that of the Canadian housing market as a whole (where the average price is about $455,000).

Those who live in the greater Toronto area may be more than willing to trade in their first born children in order to see average house prices sub $500k.

But perhaps that is an article for another day…

What would be interesting to explore further though, is whether the stress test has indeed caused more harm than good in the housing market.

Let’s first explore what exactly the stress test is so we can paint a more accurate picture of the circumstances at hand.

The stress test in and of itself isn’t a test in the traditional sense per se, but more of a set of rules simply used to properly assess whether an individual can qualify for a mortgage and the amount available to borrow. It was created with the intention of protecting borrowers  just in case (or more like when) interest rates begin to creep up once again. Do note that interest rates are currently historically low, so it’s simply a matter of time before they begin to rise again.

As per Tamar Satov from MoneySense, here’s how it works,

“When you apply for a mortgage, the lowest rate the bank can use to determine your eligibility is the posted Bank of Canada five-year rate, which is currently 5.34%. (Or, if the rate your bank is offering you, plus 2 per cent, is higher than the Bank of Canada rate, then that’s the minimum qualifying rate that will be used.) To put this into real terms, if you wanted to borrow $400,000 and the bank is offering you a rate of 3.5%, you would have to prove you can afford a mortgage payment of about $2,440 per month (at 5.5%), even though your actual monthly mortgage payment (at 3.5%) would be just under $2,000.”

Essentially the stress test eats into the amount one can borrow and, with house prices being what they are in the GTA, this drastically reduces the ability for people to enter the market, as evidenced by the 16.1% drop in new sales from 2017 to 2018. Many prospective home owners simply were not able to qualify for their original home type and location preferences and therefor put their decision to purchase on pause, or at least while they reconsidered their options.

This was particularly felt by first time home buyers which according to an Ipsos survey of homeowners, the share of first time home buyers remained below 50%.

Dave Wilkes, President and CEO of BILD (Building Industry and Land Development Association) believes that the stress test has overshot its target, meaning that perhaps it may have put a damper on the market a little too large.

With that being said, it appears that his assessment was correct because, as of July 2019, the Bank of Canada has indeed lowered it’s benchmark for the stress test from 5.34% to 5.19%%. While not a massive stretch by any means, it will give prospective home buyers a bit more purchasing power and the ability to discover to larger pond of home selection.

This move would seem to indicate that the Bank of Canada has deemed their original benchmarks for the stress test more prohibitive than protective but, only time will tell if the updated rate will prove beneficial to Canadians in their quest for home ownership.