24 January 2019

Last year, home sales fell by 11%, but the amount of outstanding mortgage credit reached $1.55 trillion.

The stress tests require first-time homebuyers and those with the existing ones to qualify at their contract rate plus 2%. According to the report, this threshold is too high as it doesn’t take into account the fact that borrowers’ income will be higher in 5 years, and a significant amount towards the principal will be already paid.

If the average wage growth is about 2%, then an average borrower’s wage will be more than 10% higher in 5 years than today. Moreover, by that time, the borrower would have paid a significant amount of principal (about 13%-14%).

That’s why the stress test should account for higher incomes and smaller principal amount. So if you need to determine whether a borrower can manage the mortgage payments in case the rates go up by 2% in 5 years, then a contract rate plus 0.75% will be enough.

In MPC’s opinion, many first-time homebuyers couldn’t qualify for the desired property or had to leave the market at all. Those who couldn’t afford a purchase under the new rules, have to rent homes, increasing the pressure on today’s tight rental market. Last year, for instance, rents rose by 3.4%.

The idea of the stress test is that when rates go up, it will raise the debt servicing costs that could lead to many foreclosures.

However, according to MPC, mortgage default rates are not affected by the rate hikes as strongly as by job losses, so the stress test can’t be a guarantee.

Actually, today mortgage arrears in Canada are at historically low 0.24% (1 in 424 borrowers), and they keep going down since 2009.

The consequences of a housing market slowdown influence the entire economy, including jobs in housing and construction, and the revenue from land-transfer and other taxes. There are also many unintended consequences, e.g. such as higher demand for rental properties.

Only stability in labour markets can lead to stability in the real estate markets. So if the government admits that the ability to manage debt payments is affected more by job losses than by rate hikes, and that incomes keep growing and the principal amount owed goes down, then there’s common sense in reviewing the stress test thresholds.