Why it’s time to revisit the mortgage stress test

Two recent housing measures—one implemented, one soon to be implemented—might not affect the housing market as positively as intended.

First, certain clients who are first-time homebuyers are subject to a mortgage stress test to determine if they could afford their mortgages if rates increased. Second, the new homebuyer incentive aims to help first-time buyers break into the market, and is expected to be implemented in 2019-20.

Problem is, both measures underwhelm when their effectiveness, or potential effectiveness, is analyzed.

The stress test for new buyers who have down payments of 20% or more uses the higher of either the five-year benchmark rate published by the Bank of Canada or the lender interest rate plus 2%.

In a report, Benjamin Tal, deputy chief economist at CIBC World Markets, put the test in context: “In today’s market you can get a five-year fixed rate of 3.5%, but you must be qualified at 5.5%.”

That 2% difference isn’t based on any real science, Tal said, and he explored whether the stress test was an effective measure to help cool the housing market.

While the test was probably necessary to “save some Canadian borrowers from themselves,” he said, it’s time to re-think the measure because of other developments that have helped stabilize the market.

For example, the stress test was introduced when the market was already slowing, he explains, and, since the test’s introduction, the five-year mortgage rate has risen 35 basis points, in step with central bank rate increases.

Also, the stress test fails to account for rising incomes. “Average personal income has risen by a cumulative 12.5% over the past five years,” Tal said.

Further, a potentially negative result of the stress test would be a fast-growing alternative lender market, with risk being transferred to the less regulated segment of the mortgage market. Alternative lenders accounted for close to 12% of the total number of mortgage transactions in 2018, up from 10% a year earlier, an increase due at least in part to the stress test, Tal said.

His bottom line is that regulators should revisit the test. “We need a more flexible benchmark,” he said.

For its part, the new homebuyer incentive introduced in the federal budget last month might help your client close their first real estate transaction, but the measure will likely help fewer people than anticipated.

The incentive is “simply too small to make a significant difference,” said Tal in the report. CIBC estimates that the measure will impact only 3% of borrowers and 0.12% of mortgage origination dollars.

The incentive should at least provide some “modest support” for housing demand going forward, said BMO chief economist Douglas Porter in a report. Though housing activity has recently been lacklustre, he forecasts a stronger housing market in the year ahead, considering such things as a pause on rate hikes from the central bank and warmer weather.

“Prices, sales and starts are likely to hold broadly stable nationally in 2019 amid the many moving parts for the market,” he said.

For full details, read the reports from CIBC and BMO.