Office of the Superintendent of Financial Institutions (OSFI) announced on Thursday as part of an annual review that the minimum qualifying rate insured mortgage – Commonly known to homebuyers and refinancers stress testing – Will not change from its current levels.
The regulator, which is in charge of setting up stress tests for uninsured mortgages in Canada, says it is “prudent” to maintain the standard, even though Rate of interest Increase from Bank of Canada presses borrowers to qualify for higher rates.
While some experts Global News spoke with on Thursday said there is a “valid argument” for easing the stress test to ease housing affordability concerns, most agreed that the standard has so far been too harsh for Canadian homeowners. and have proven effective in shielding lenders from the shock of high. Rate of interest.
What is mortgage stress test?
Today, those applying for a mortgage They have to prove that they can handle payments that exceed the actual contract rate offered by their lender. That rate remains at 5.25 percent or the mortgage contracting rate plus two percentage points, whichever is higher.
For most of the COVID-19 pandemic, when the Bank of Canada’s key interest rate was at historic lows, many Canadian borrowers were qualifying for the 5.25 per cent rate.
That’s all set to change with the central bank raising its benchmark rate sharply until 2022.
Interest rates have increased in 2022. Here’s How Much You’re Overpaying To Borrow
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Canada’s largest banks responded by raising their prime lending rates to 6.45 per cent. Bank of Canada’s 50-basis-point rate hike In the past week, the stress test for some Canadian mortgage seekers has exceeded eight per cent.
Some provincially regulated lenders do not require borrowers to be subjected to OSFI’s stress test. OSFI’s stress test also applies only to uninsured mortgages, although the federal Department of Finance has matched the regulator’s qualification standard on insured products.
The department confirmed in a statement Thursday that Ottawa’s test for insured mortgages will also remain unchanged.
Why do we have a mortgage stress test?
According to OSFI, the goal of stress testing is to protect Canadian borrowers by ensuring they can continue making loan payments in the midst of a sudden increase in interest rates or an economic downturn.
OSFI said in a brief statement Thursday that while today’s mortgage applicants are already qualifying in a higher rate environment, stress testing remains a “good” practice for lenders.
“In an environment characterized by rising mortgage interest rates, persistent high inflation and potential risks to borrower income, it is prudent that lenders continue to test borrowers for adverse conditions,” the statement said.
Speaking to reporters on the way out of a Liberal cabinet meeting on Thursday, Finance Minister Chrystia Freeland said Canada’s “well-regulated mortgage system” is one of the “fundamental strengths” of its financial sector.
He cited the safety in the mortgage space as the reason Canadian banks were not hit hard by the 2008 financial crisis.
“In the situation we are in today, it makes sense for Canada to continue its tradition of being careful, being considerate, being prudent. That’s the approach OSFI has taken and that’s the approach the Ministry of Finance has taken,” Freeland said.
Is stress testing effective?
Economists and real estate experts who spoke to Global News on Thursday largely agreed that the stress test has worked its way through 2022, as rapidly rising rates could overwhelm buyers and lead to an increase in mortgage defaults. .
Tolga Yalkin, assistant superintendent at OSFI, told reporters at a press conference on Thursday that the regulator credits the stress test with keeping the stock “at or near historic lows.”
“This margin of safety made it easier for Canadian homeowners to pay their mortgages and stay in their homes while rates continued to rise,” he said.
Stephen Brown, senior economist for Canada at Capital Economics, told Global News that while stress testing is “certainly not popular” among homebuyers, the relative stability of the housing market in 2022 is positive for the effectiveness of stress testing.
He points to data from the Canadian Real Estate Association (CREA), also released on Thursday, that showed a decrease in listings for new homes in November.
If Canadians were unable to keep up with their mortgages as costs rose, we would be seeing a wave of properties flooding the market, he argues – something Canada saw in the 1980s when rates rose rapidly without a buffer. Had happened. OSFI’s stress test was introduced in January 2018.
“New listings grew very quickly (in the ’80s) because people were almost being forced to sell their homes, whereas we’re seeing the opposite this time. People were able to sit on the sidelines, even though ( These high interest rates) are biting, it is not forcing them to sell these houses because they cannot afford them,” he says.
What would have been the effect of OSFI reducing the stress test?
Shifting the stress test will have an immediate impact on housing demand and purchasing power, according to experts who spoke to Global News.
Rates.ca mortgage and real estate expert Victor Tran says that for every 25 basis points higher the stress test will increase, the average buyer will lose $10,000 to 15,000 in purchasing power over the home’s final purchase price.
Tran says maintaining the stress test means Canadians will have to qualify for mortgages at higher rates given the Bank of Canada’s decision last week to continue reducing affordability.
If OSFI had made the stress test easier, it would have expanded the borrowing power of Canadians.
John Pasalis, president of Realosophy Realty in Toronto, says there’s a case to be made for skipping the stress test now that rates have already gone up. It is unlikely that interest rates will rise another two percentage points given the message from the Bank of Canada about a possible pause in hikes on the horizon.
“Can they relax it a little bit as we start to make it more stable or … interest rates potentially going downward? I think that’s a valid argument,” Pasalis says. “But again, I think policymakers want to take a very conservative position right now.”
Brown says now may not be the time to lower the railing on the Canadian housing market.
While it is true that rising rates have not yet caused widespread mortgage defaults in Canada this year, it may take a year or more for higher interest rates to work their way through the system. Mortgage holders with fixed rates or steady payments won’t feel the pain of higher rates until they upgrade, Brown noted, and the market could feel the impact of increased borrowing costs over the delay.
At the same time, fears of a recession could lead to job losses in Canada in the coming months, with Capital Economics forecasting the unemployment rate could rise to 6.5 per cent next year from the 5.2 per cent seen in November.
The stress test is designed to protect the mortgage industry not only from higher rates, but also from unexpected hits to income, Brown notes.
“Many of those people (who may lose jobs) will be home owners and may find themselves in trouble. But due to much stress testing, they probably proved they’ve got some savings. They can employ them both. It gives them a little buffer,” he says.
And just because interest rates have risen significantly in 2022 doesn’t mean they can’t rise further in 2023 if there are more shocks to the global economy like the war in Ukraine last year, Brown says.
What other changes can be made to the stress test?
OSFI also said it would begin a review of stress tests and other mortgage underwriting standards in January. The regulator said it expected to drop the stress test after its review, “although there could be immediate changes in the economic environment.”
At the end of the summer, the Toronto Regional Real Estate Board (TRREB) asked OSFI to review the stress test to give consumers more flexibility to switch their mortgages to a different lender. Currently, when a mortgage holder is refinancing or looking to change lenders, they must be required to stress test the mortgage under the parameters.
Pasalis agrees that mortgage renovators can benefit from added flexibility in the current interest rate landscape to renegotiate amortization for a more lenient payment schedule on their mortgages or to secure a cheaper rate with another provider.
Such moves would not introduce a new mortgage—introducing new risk into the system—but would help homeowners mitigate the impact of rising rates and possibly avoid defaults, he says.
“This is where I think it would be more prudent to make some changes to make it a little easier for existing homeowners,” says Pasalis.
OSFI is committed to reviewing the stress test every year.
With files from Global News’ Kyle Benning