Is it time for the mortgage stress test to be adjusted?

Current interest rates means there's a case to be made for a change, says market analyst

Is it time for the mortgage stress test to be adjusted?

The fact that the level many borrowers are now being stress-tested at is “probably not realistic looking forward” means a case could be made for adjusting the current mortgage qualifying rate, according to a senior analyst for Toronto’s real estate board.

Jason Mercer (pictured) of TRREB (Toronto Regional Real Estate Board) told Canadian Mortgage Professional that the qualifying rate of the higher between 5.25% and the contract rate plus two percentage points was weighing down on housing affordability following a series of interest rate increases throughout last year.

“I think the stress test certainly is hampering people’s ability to purchase a home. And I think that there’s room for reconsideration of the stress test,” he said. “TRREB’s not saying that prudent mortgage lending guidelines aren’t important – they very much are.

“If you look at the performance of our mortgage market over successive cycles over the last two or three decades, we’ve seen very low default rates up against our peer nations, and so it’s important, but at the same time there needs to be some regard for where you are within the economic and housing market cycle.”

What has OSFI said about the future of the stress test?

The Office of the Superintendent of Financial Institutions (OSFI), which regulates Canada’s financial sector, announced in December that it would be leaving the stress test unchanged following its annual review.

The regulator said it was prudent for borrowers to be tested for adverse conditions, with the qualifying rate representing a “key tool supporting sound mortgage underwriting.”

Superintendent Peter Routledge also said in a January 9 speech that OSFI was reviewing the B-20 guidelines, which were introduced to ensure the stability of Canada’s financial system, with a view to potentially introducing further tests for borrowers aside from the qualifying rate.

“The question in our minds is, is it sufficient?” he said. “So we will look at a broader range of debt serviceability tools, including debt-to-income constraints, debt-service constraints, as well as the current interest-rate stress test tool.”

With most contract rates now sitting above 5.25%, Mercer said a reasonable argument could be made that the current stress test level is unrealistic in today’s market.

“Where we are in this tightening cycle… the expectation is shorter-term rates to trend lower in the latter half of 2023 and into 2024 as we start to see some brakes put on the economy,” he said.

“And so, should the stress test be a little bit more dynamic relative to where we are in the economic cycle? I think there’s certainly an argument there, that should be considered and [it] seems a little bit arbitrary, a little bit static in that regard.”

How is the stress test impacting existing homeowners?

Current homebuyers who wish to search for competitive rates must qualify through the stress test if they want to switch lenders – but aren’t required to do so if they renew with their existing one.

That’s potentially harmful to competitiveness in the mortgage market, Mercer said, with existing lenders having an advantage over other financial institutions and possibly their borrower when it comes to mortgages that are up for renewal.

“If I’m going out and I’m not looking for any new funds – all I want to do is renew our mortgage, but I want to be able to go out there and compete in the marketplace and get the best deal I can – I’ve got to be stress tested because I go to the lender down the road,” he said. “That doesn’t make a lot of sense.

“In that scenario, are you going to get the best rate? If your existing lender knows that you don’t get stress tested with them, but you get stress tested with any other lender who may be offering more competitive rates, it creates an asymmetry.

“We promote competition in our economic framework in Canada,” Mercer said, “yet that type of policy that precludes people being able to go out and negotiate, shop for the best rate – I think there’s room for adjustment in that framework as well.”

What are your views on Canada’s mortgage qualifying rate and whether it should be adjusted or amended? Let us know in the comments section below.