August 9, 2019 Kristen Godel

Stress Test in a Nutshell

What is it?
Simply put, mortgage seekers must qualify (on paper) at a rate that is 200 basis points (2%) higher than the contract rate being offered by the bank. For the purpose of this example, if the contract rate being offered is 3.34% on a 5-year fixed term, the bank must ensure that you can also afford the same mortgage at 5.34%. This test applies to both variable and fixed mortgage terms, regardless of length (or other variables such as amortization, credit, income, or loan size).

Why was it introduced?
The stress test was introduced to ensure borrowers are not over extending themselves on debt or ‘borrowing to capacity’. Consumer household debt in Canada, prior to this test, was at worrisome levels. This, coupled with record setting house prices, was a bad mix for the Canadian economy. Some speculate that the stress test was introduced to lower house prices, but we believe that this was just an inevitable result, not the actual goal of OSFI. Having been on the financing side for quite some time, we can agree that standard underwriting practise was missing the necessary ‘buffer’ clause to ensure borrowers weren’t exposing themselves to future financial difficulty.

Was the intended outcome achieved?
Short answer -Yes. With over 1 full year of data (as of January 2019), it’s been revealed that high risk lending has decreased, while quality of credit has improved. Let’s not forget that some form of the stress test did exist prior to January 1, 2018. In 2016, stress testing was applied to all high ratio mortgages (any mortgage greater than 80% loan-to-value and default insured). That however did not yield the result intended.

Was there an effect on the real estate market?
Absolutely. The housing market has noticeably stabilized (some will say ‘weakened’) as a result of the stress tests. This is mainly a result of decreased purchasing power (-20% on average). The less people can afford across the board, the less demand… and the less demand, the lower prices will need to be in order to sell. There are two ways to look at this, and it really depends on whether you are a home owner or a buyer in the market. Home owners see money going out the window due to decreases in prices (equity). Home buyers see opportunities for more affordable housing and more negotiating power.
Borrower beware: It’s very important to note that as a result of the stress test, many potential buyers’ plans have been seized through traditional financing. As such, some are seeking out alternative options through completely private options at much higher rates. Discussions for an exit strategy must be had.

For more information, please call us at (905) 455-5005. We’re always here for your support.