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11 December 2019

Mortgage stress test worsens housing supply issue and makes homes even less affordable

Today, Canada is showing sustained economic and strong population growth. Millennials and new Canadians are creating households and they express strong desire to have their own real estate, especially amid low interest rates. It seems that with such conditions we should see growing home sales and supply increasing alongside demand, supporting the prices at normal levels. However, the real estate supply is restrained and home prices are growing sharply in the major markets.

Michael Bourque, CEO of the Canadian Real Estate Association, blames the government for it. In his opinion, a strong focus on lowering household debt has dominated the policy, while the main reasons of this undersupply (excessive red tape, fees, taxes and nimbyism) are almost not affected.

In case we want to solve the housing affordability issue in Canada, governments need to review their policy mix and address those reasons, starting with a more flexible mortgage stress test.

First of all, it’s necessary to view mortgage debt in the Canadian context. Canadian consumers show some of the highest rates of home ownership and mortgage borrowing in the entire world. Nevertheless, Canadians use their mortgage debt responsibly with making additional payments or accelerating paying off in other ways.

According to Equifax, credit scores for first-time Canadian homebuyers are “very good,” and they tend to keep improving fast during the first three years of home ownership.

In addition to it, there is strong evidence that Canadians strongly value home ownership. It’s considered a top priority in all age categories: from millennials to baby boomers. The possibility of homeownership remains one of the main attraction for immigrants.

However, in spite of all that, potential homebuyers today face restrictions from numerous government policies that need to be edited, especially when it comes to the mortgage stress test.

Although a one-size-fits-all approach helped cool overheated markets, it also led to destabilization of Prairie real estate markets, which were already hit by region’s economic slowdown. The stress test was introduced 23 months ago. Initially, policy-makers wanted to make sure borrowers would be able to manage their debts when they need to renew their mortgages – mostly, because rate increases were expected. And now many predict rate cuts amid weak economic growth, trade tensions and other factors. So it’s time to ask ourselves, whether this small improvement in mortgage credit quality caused by the stress test was worth all unintended consequences.

Those buyers who have been pushed out of the market by the test search for financing at higher interest rates. So how many borrowers had to accept higher rates just to get the house of their dreams? There is no exact data, but we know that this sector of the mortgage market has increased sharply in Canada, particularly among entrepreneurs and new Canadians.

Meanwhile, those who want to buy properties they have chosen before the stress test implementation, but don’t want or can’t address alternative lenders, now have to provide much larger down payments or choose a cheaper home. Nevertheless, lower-priced listings are extremely restrained now, so the stress test only made it more difficult for buyers to find entry-level homes. Sometimes, it’s because the mortgage stress test reduces homebuyers’ purchasing power, and homeowners decide to postpone selling their first home and upgrade. As a result, the mortgage stress test is limiting the supply of less expensive resale homes.

The same scenario is seen in the sector of new home construction, with housing starts not keeping the pace with the strong population growth. As numerous first-time homebuyers are pushed out of the market by the stress test, many builders cut their sales forecasts and reduced building. It also affects rental and resale markets. Lack of supply amid strong demand will keep influencing home prices and rents making it even less affordable.

Of course, it’s important to address the household debt problem, but restraining the demand is not the way to do it. It’s necessary to review the current approaches on all levels of government: from federal to municipal, from infrastructure spending to zoning, permitting and taxation. Yes, it will require huge efforts nationwide, but ignoring the supply issues will only harm the economic growth and the entire Canadian economy.



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