Does a mortgage stress test still make sense in Canada?

This month, we’ve seen the Bank of England canceling its mortgage stress test. As mortgage rates today exceed 4% and 5%, and some believe we’re heading to a peak of this rate-increase cycle, the question pops up: is it time to make adjustments to Canada’s stress test?

As you know, with the current mortgage stress test, both insured and uninsured mortgage borrowers have to prove they can handle their monthly mortgage payments based on a rate of 5.25% or their contract rate plus 2% (the higher one is chosen). Today, borrowers are usually facing a stress-test at about 6% and 7%.

The stress test for insured mortgages (with a down payment of less than 20%) was introduced in 2016 by the Department of Finance. In 2018, the Office of the Superintendent of Financial Institutions (OSFI) followed with its own test for uninsured mortgages (with a down payment of more than 20%).

They were implemented as a respond to risks the government and the OSFI saw in high household debt level and high home prices, combined with historically low interest rates.

Is it time to change the stress test?

Now, housing prices are going down all over Canada following their February peak. Meanwhile, interest rates are rising sharply as the central bank tries to restrain the inflation that has reached the highest level since the 1980s.

Do the mortgage stress test rules even make sense these days?

According to JP Boutros, director of government relations at Mortgage Professionals Canada, they’re pushing Canadians out of the real estate market. “There was a really good opportunity for people in 2020 and 2021 to enter the market with fixed money, but they weren’t able to do that because the stress test was so much higher than the real interest rates they could get,” – explained Boutros.

When fixed rates began to outpace the variable ones earlier in 2022, the stress test qualification rules forced many borrowers to chose variable rates, as it was the only option they could actually qualify for.

The report by the Canada Mortgage and Housing Corporation (CMHC) shows 56.9% of mortgages taken out earlier this year were variable-rate products.

In Boutros’ opinion, the Department of Finance and OSFI should be adjusting the requirements of the mortgage stress test. “They should have reduced the stress test in 2020 and 2021 in order to let first-time homebuyers enter the market and compete with the well-capitalized,” – he noted.

However, both the Department of Finance Canada and OSFI remain silent when it comes to any potential changes to the mortgage stress test. The only thing they said was that they watched the market closely and would consider adjustments when necessary.