Mortgage stress test remains unchanged. What it means in the context of higher interest rates – Country
The Office of the Director of Financial Institutions (OSFI) announced as part of its annual review on Thursday that the minimum qualifying rate for uninsured mortgage — often referred to by homebuyers and refinancers as stress test – will remain unchanged from its current level.
The regulator, which is responsible for setting the stress test for uninsured mortgages in Canada, said maintaining the standard was “cautious” even if interest rate increases from the Bank of Canada force borrowers to qualify at higher interest rates.
While several experts who spoke to Global News on Thursday said there was a “sound argument” for lowering stress testing to ease concerns about housing affordability, most agreed. that the standard has so far proven effective in protecting Canadian homeowners and lenders from the shock of higher home prices. interest rate.
What is a mortgage stress test?
Today, those who apply for Mortgage must demonstrate that they can process payments above the actual contract rate offered by the lender. That rate is still 5.25 percent or the mortgage contract rate plus two percentage points, whichever is higher.
During much of the COVID-19 pandemic, when the Bank of Canada’s prime rate was at historic lows, many Canadian borrowers qualified at the 5.25% interest rate.
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That changed with the central bank rapidly raising its benchmark interest rate through 2022.
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After Canada’s largest banks raised their prime lending rates to 6.45% in response Bank of Canada raises interest rates by 50 basis points Last week, the stress test for some Canadian mortgage seekers was above eight percent.
Some provincially regulated lenders do not require borrowers to be subjected to an OSFI stress test. OSFI’s stress test also only applies to uninsured mortgages, although the federal Treasury Department has matched the regulator’s eligibility criteria for insured products.
The department confirmed in a statement Thursday that Ottawa’s test for insured mortgages would also remain unchanged.
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Why do we have a mortgage stress test?
According to the OSFI, the goal of the stress test is to protect Canadian borrowers by ensuring they can continue to make loan payments during a sudden interest rate hike or economic downturn.
OSFI said in a brief statement on Thursday that although mortgage applicants today qualify in a higher-interest rate environment, stress testing remains a common practice. right” for lenders.
“In an environment characterized by rising mortgage rates, persistently high inflation and potential risks to borrower income, it is prudent for lenders to continue to check for adverse conditions. of the borrower,” the statement read.
Speaking to reporters on her way out of a Liberal cabinet meeting on Thursday, Finance Minister Chrystia Freeland said Canada’s “well-managed mortgage system” is one of its “fundamental strengths.” of the financial sector.
She cited protections in the mortgage sector as one of the reasons Canadian banks weren’t hit hard during the 2008 financial crisis.
“In the current situation, Canada should continue its tradition of being careful, thoughtful and prudent. That’s the approach that OSFI has taken and that’s the approach that the Treasury Department has taken,” said Freeland.
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Are stress tests effective?
Economists and real estate experts who spoke to Global News on Thursday largely agreed that the stress test appears to have done its job through 2022, as rapidly rising interest rates could overwhelmed buyers and spurred an increase in mortgage defaults.
Tolga Yalkin, assistant general manager at OSFI, told reporters during a press conference on Thursday that the regulator believes the stress test has kept mortgage delinquency levels “at or near low levels.” the best in history”.
“This margin of safety makes it easier for Canadian homeowners to pay off their mortgages and stay in their homes while interest rates start to rise,” he said.
Stephen Brown, senior Canadian economist at Capital Economics, told Global News that while stress tests are “certainly uncommon” among homebuyers, the housing market’s relative stability in 2022 is positive evidence for the effectiveness of the stress test.
He pointed to statistics from the Canadian Real Estate Association (CREA) also released on Thursday that showed a drop in the number of new homes for sale in November.
If Canadians can’t keep up with their mortgages as costs go up, he argues, we’ll see a flood of real estate flood the market, he argues — something Canada has already seen. in the 1980s when interest rates rose rapidly without a buffer zone. The OSFI stress test was introduced in January 2018.
“New listings grew very strongly (in the 80s) because people were forced to sell their homes almost in bulk, whereas we see the opposite happening at this point. People can sit on the sidelines, even though (these higher interest rates) are nagging, but that doesn’t force them to sell these homes because they can’t afford them,” he said.
What impact will OSFI lowering the stress test have?
Changing the stress test will have an immediate impact on housing demand and purchasing power, according to experts who spoke to Global News.
Victor Tran, mortgage and real estate expert at Rates.ca, says that for every 25 basis points higher on an increased stress test, the average buyer loses between $10,000 and $15,000 in money. buy above the final purchase price of a home.
Maintaining a stress test means Canadians will have to qualify for higher-interest mortgages under a decision by the Bank of Canada last week, Tran said, which will further reduce ability to pay.
If OSFI had relaxed the stress test, it would have expanded Canadians’ ability to borrow.
Higher loan interest rates affect Canadian homeowners
John Pasalis, president of Realosophy Realty in Toronto, says the stress test can be skipped because rates have increased. He noted that it is unlikely that interest rates will rise another two percentage points, given the announcement from the Bank of Canada that it may pause rate hikes in the near term.
“Can they loosen it up a bit now that we start to get into a more stable trend or… a downtrend possible? I think that’s a valid argument,” Pasalis said. “But again, I think policymakers want a very conservative stance right now.”
Brown says now may not be the time to lower barriers for the Canadian housing market.
While it is true that rising interest rates have not yet led to widespread mortgage defaults in Canada this year, higher rates could take a year or longer to impact the system. Holders of fixed-rate or fixed-payment mortgages won’t feel the pinch of higher rates until they renew, Brown noted, and the market could feel the impact of the increase. borrowing costs for delay.
At the same time, fears of an impending recession could lead to job losses in Canada in the coming months, with Capital Economics predicting the unemployment rate could rise to 6.5% next year from the current rate. rate of 5.2% seen in November.
Brown notes that the stress test is designed to prevent the mortgage industry from not only having higher interest rates, but also from unexpected effects on earnings.
“Many of those people (who may lose their jobs) will become homeowners and it may be difficult. But because the exam was so stressful, they probably proved that they had some savings. They can put those two to work. It gives them a bit of a buffer,” he said.
And just because interest rates have risen significantly in 2022, doesn’t mean they can’t rise further in 2023 if there are additional shocks to the global economy like the war in Ukraine last year, Brown added. .
What other changes can be made to the stress test?
OSFI also said it will issue a review of the stress test and other mortgage underwriting standards in January. The regulator said it expected to keep the stress test unchanged after the review, “although the economic environment could lead to a more immediate change.”
Late in the summer, the Toronto Area Real Estate Board (TRREB) called on OSFI to consider stress testing to give consumers more flexibility in transferring their mortgage to another lender. Currently, when a mortgage holder is refinancing or looking to switch lenders, they must qualify for a mortgage under stress test parameters.
Pasalis agrees that mortgage extenders could benefit from additional flexibility amid current interest rates, to renegotiate their mortgage amortization into a softer payment schedule, or Guaranteed cheaper price with other supplier.
Such moves won’t start a new mortgage – introducing new risks into the system, he said – but help homeowners mitigate the impact of rising interest rates and possibly avoid default.
“It’s a space where I think it would be wiser to have a few changes to make it a little easier for existing homeowners,” says Pasalis.
OSFI has committed to an annual stress test review.
— with files from Kyle Benning of Global News