Mortgage Professionals of Canada just released their annual residential mortgage report and they paint an unflattering image of last year’s federally implemented mortgage stress test.
Will Dunning, the author of the report and Chief Economist for the Mortgage Professionals of Canada, states he is concerned at how government policies over the last 10 years have progressively made it more and more difficult for current homeowners to make financial decisions that would be in their best interest. Though the report doesn’t outright say that last year’s mortgage stress test was a complete mistake — it implies that it was implemented hastily and without enough foresight.
At present, a home buyer needs to qualify for a mortgage at 200 basis points (2%) higher than the current five-year discounted rate that’s offered by most lenders. Fail to qualify and the buyer is denied a mortgage (or must readjust their house-buying budget).
Current mortgage stress test fails to consider earning capacity and borrower habits
In his report, Dunning admits that it’s reasonable to test if a borrower’s capacity to pay their mortgage could be affected by higher interest rates. After all, he states, it’s almost certain the Bank of Canada will increase its overnight interest rates later this year, which would prompt additional mortgage rate increases. Dunning points out, however, that the current stress test fails to consider that most incomes rise annually, as well, typically at a rate of around 2%.
Dunning goes on to explain that the stress test fails to consider how principal repayments change how interest rates are calculated in the future. In the first five years alone, a typical homeowner pays around 13% to 14% of their principal. The higher interest rate assumed by the stress test doesn’t account for a reduction in principal, he writes.
Then there are the proactive borrowers. At least a third of all Canadian mortgage holders take steps towards paying off their mortgage earlier.
As Dunning puts it, the current mortgage stress underestimates the capacity of Canadian homeowners to carry a mortgage and adds an unnecessarily challenge for otherwise qualified individuals before they can purchase a home.
Mortgage stress test negatively impacts resale value of homes
Additionally, the effect the stress test on resale activity across all Canadian housing markets was much stronger than anticipated. Last year’s report predicted that 2018 would see a decrease of around 7% to 8% in sales compared to 2017, mostly due to the effects of the then soon to be implemented mortgage stress test. The actual drop in activity was around 11%, although the report admits that the two increases in BoC’s interest rates and the foreign investor taxes in Canada’s two largest real estate markets played a role in that reduction as well.
Dunning is concerned that this drop in housing activity could have a serious effect on the economy as a whole. “In a modern economy, one of the most dangerous risks is that if house prices fall, the impairment of consumer confidence will weaken the broader economy. The mortgage stress tests are raising the risks to house prices and the economy of Canada.”