What is the Mortgage Stress Test?
Simply put, mortgage borrowers must qualify (on paper) at an interest rate that is the higher of:
- The rate being offered by the bank (the ‘contract rate’) + 2.00%
- OR 5.25% (the benchmark, or ‘qualifying’ rate)
For example, if the contract rate being offered is 5.49% on a 5-year fixed term, the bank must ensure that you can also afford the same mortgage at 7.49% (5.49% + 2.00%).
The benchmark rate of 5.25% would not apply in this scenario, as the contract rate + 200 basis points is higher than 5.25%.
This stress test applies to both variable and fixed mortgage terms, regardless of the down payment, length of the term, amortization, credit, income, or loan size.
Why was the Mortgage Stress Test introduced?
The stress test was introduced to build in a margin of financial safety by ensuring that homeowners are not ‘borrowing to their capacity’. This allows for margin or ‘wiggle room’ if/when interest rates increase, or if household income drops. This stress test, although a nuisance, could not have been more effective than it has been throughout 2022-2023 (and is likely to continue its effectiveness throughout 2024). Before the inception of the stress test, consumer household debt in Canada was at worrisome levels (and still is in 2023 due to inflationary pressure). 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 OSFI (Office of the Superintendent of Financial Institutions) has clearly stated its intentions:
“The minimum qualifying rate adds a margin of safety that ensures borrowers will have the ability to make mortgage payments in the event of a change in circumstances, such as the reduction of income or a rise in mortgage interest rates. As mortgages are one of the largest exposures that most banks carry, ensuring that borrowers can repay their loans strongly contributes to the continued safety and soundness of Canada’s financial system.”
– Office of the Superintendent of Financial Institutions (OSFI)
Was the goal of the Mortgage Stress Test achieved?
Short answer -Yes. With almost 7 full years of data, it’s been revealed that high-risk lending has decreased, while the quality of credit has improved. Let’s not forget that some form of the stress test did exist before 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 full result intended.
What is the Mortgage Stress Test’s impact on housing prices?
Before the pandemic, the housing market had noticeably stabilized (with moderate/healthy growth) because of the stress tests. This is mainly a result of decreased purchasing power (10% on average). The fewer people can afford across the board, the less demand there is… and the lower the demand, the fairer prices will need to be to sell. There are two ways to look at this, and it depends on whether you are a homeowner or a buyer in the market. Homeowners see money going out the window due to decreases in prices (equity). Home buyers see opportunities for more affordable housing and more negotiating power. It’s very important to note that because of the stress test, many potential buyers’ plans have been seized through traditional financing. As such, some are seeking out alternative options through B-lenders or completely private options at much higher rates. Discussions for an exit strategy must be had if you need private financing to purchase or refinance!
** (It’s important to note that the stress test was less effective during the quantitative easing phase (driven by the covid-19 pandemic) during 2020 – early 2022. This is because rates were at all time lows, which boosted everyone purchasing power – thus driving up home prices).
The most important Mortgage Stress Test questions: How often do I need to requalify?
As of writing (December 2023), OSFI’s rules for the stress test are:
- New purchases: All new purchases, insured or uninsured, must qualify using the stress test rules.
- All refinances continue to be requalified at the stress test at the time of refinancing.
- All Insured Switches and Insured Collateral Transfers no longer need to qualify at the stress test, and instead can qualify at the contract rate (this applies to any purchase that was originally default insured).
Although the stress test exists, we work hard every time to provide you with a stress-free mortgage experience. For more information, please call us at (905) 455-5005.