The Office of the Superintendent of Financial Institutions Canada (OSFI) Mortgage Stress Test was introduced in 2018, when every Canadian buyer applying for mortgage from a federally-regulated lender were required to undergo it. This was applicable for even those who put down 20% or more as down payment.
What is the Canadian Mortgage Stress Test?
The idea is simple – the stress test was structured to ensure that mortgage applicants can fulfill the obligation to make payments even if rates spike in future. To pass the test, you have to qualify at the Bank of Canada’s current five-year benchmark rate which is 5.34% since May 2018 or contracted mortgage interest rate plus 2%, whichever is higher. The outcome is that a large portion of new homebuyers, have had their purchasing power cruelly slashed by as much as 20% as they are only eligible for a lower loan amount at the mortgage stress-tested rates. The test affects present homeowners looking to renew or refinance mortgage – it has gotten considerably more difficult to do so.
What is the need for this test?
The problem is household debt in Canada has reached epic proportions – the test was specifically designed to ensure consumers don’t dig themselves into deeper debt by securing a mortgage that is too big for them. The average household in Canada is indebted at 170% of their disposable income, which means that Canadians owe $1.70 for every dollar they earn after taxes.
The OSFI has tweaked a few rules when it comes to mortgage and housing. The test was applicable to those who were paying less than 20% down payment, but now everyone has to undergo the test, as mentioned above. This regulation is also applicable to those who wish to change to a different lender when their mortgage expires.
What has been the overall effect?
A report was released from Teranet that clearly shows that the stress test has adversely affected mortgage markets, among which Canada’s banks have been the biggest losers thanks to the new rules. For instance, the Big 5 banks saw their share of mortgages in Ontario drop to 72.6% in 2018 from 75.3% in the previous year.
Mortgage refinancing and switches have seen sharp decline
The Teranet report revealed that due to the stress test, there has been a fall of 24% in mortgage refinances and switches, which amounts to almost 50,000 mortgages, in a span of a year. It could be a result of people with mortgages sticking through their term and refraining from exploring other options for refinancing or switching as actively as before.
Mortgage switches involved with the Big 5 banks dropped 5.5 percentage points, which means 8000 switches to 54.5% in 2019. Meanwhile, switches from the big banks to other lenders increased 2.1 percentage points to 34.3%. Since the Big 5 has lost almost 3% market share, it is safe to say the stress test hasn’t done any favors for them!
What is the economic fallout?
Will Dunning, Chief Economist at Mortgage Professionals Canada, released a report that talked about numerous economical consequences due to the stress test, such as an 11% year-over-year decline in home resale activity. Yes, home prices have fallen as per Canada Mortgage and Housing Corporation CEO Evan Siddall. He says that homes are 40,000 (5.3%) cheaper in Toronto because of the stress test and double that (over $80,000 or 7.9% per cent) in Vancouver.
It might look like all is well for first time home buyers in the country’s most competitive markets since the reduction in prices will encourage them to invest in properties, but you have to consider the economic impact too. The mortgage stress test will lead to employment in Canada to be least 200,000 lower than it would otherwise be, after adjustments have been taken into account. The reduced housing activity coupled with negative housing wealth effect has also affected it.
As of now, the mortgage stress test isn’t working out well, but perhaps a few tweaks in future can result in different outcomes!