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On June 1, the Bank of Canada’s mortgage stress test is getting tougher, rising to a minimum of 5.25% for an uninsured mortgage. What does that mean for you? That might depend on where you live.
What is the stress test?
Any buyer looking to get an uninsured mortgage (one with 20% or more down) needs to pass a “stress test” on that mortgage. Basically, they need to prove to their lender that even if their financial situation changes, they’ll still be able to make their mortgage payments and avoid defaulting. The B-20 stress test did this by simulating an increase in the interest rate to the current rate plus 2%, or to 4.79%, whichever is higher. That minimum is going up.
Because the current interest rate is so low and despite the extra buying power that would imply, you currently need to be able to qualify for your mortgage as if interest rates were 19 times higher than where they are. As of June 1, that simulated interest rate will be 21 times higher than the real rate.
Why are changes coming?
Stress testing was introduced back in 2018 by the Office of the Superintendent of Financial Institutions (the OSFI), the independent regulator for banks in Canada as part of attempts to cool off the red-hot real estate markets in Ontario and BC. As part of this effort, the Bank of Canada (the BoC) also raised the overnight interest rate steadily through the year. But the BoC dropped it to 0.25% in March of 2020 as a response to COVID-19. The fear was that the instability brought on by the pandemic would drop the bottom out of the housing market.
With pandemic recovery taking longer than anyone expected back in early 2020, interest rates have stayed down as the BoC waits to see how the vaccine rollout goes nationally before raising them again. But in the meantime, real estate never stopped heating up. The historically low interest rate has driven a flurry of activity in Canada’s biggest markets—much of it from borrowers already heavily in debt.
That, according to the OSFI, is the reason for the more intensive stress test. They feel the increase in heavily indebted buyers leaves the housing market vulnerable. By widening the buffer borrowers need to put between their current financial situation and what the future might bring, the OSFI hopes to make investing safer for the banks it regulates.
The effects may be felt quite differently from market to market. Take just two examples:
British Columbia
With limited supply and ravenous domestic and foreign demand, Vancouver is part of the reason for the stress test in the first place. But the Vancouver market also has a unique risk factor: buyers today, facing multiple competing bids, are making subject-free offers on homes. That is, no longer having a home inspection as a sale condition—on 90% of homes in the Metro Vancouver area, according to the Home Inspectors Association of BC. That means many are closing on houses with expensive hidden issues waiting to show themselves. With most homebuyers in the area now taking on much greater risk, a tougher stress test might be able to better help Vancouver borrowers navigate their higher-risk purchases by lowering the ceiling of how much exposure they can incur.
Alberta
The Alberta market has the opposite problem of BC, especially in Calgary. Since the oil crash in 2014, excess supply has defined the market, and even though Calgary has seen some recent action thanks to the current low interest rate, it’s hardly overheated. But folks in Alberta are still feeling the pinch of a pandemic economy on top of the lasting impact of both the oil crash and the Great Recession, so the stress test changes aren’t getting a warm welcome there. Many Alberta homebuyers feel restricted by the stress test requirements, which they feel aren’t needed since the test was introduced to try and cool off Toronto and Vancouver. The June 1 increase threatens to make the situation in Calgary even worse for borrowers, especially first-time homebuyers.
Where does that leave you?
No matter how you slice it, the increase to the stress test minimum is going to shave down homebuyers’ purchasing power. It’s important to remember that while regulation like this can feel targeted at borrowers, these effects are a byproduct of the OSFI trying to brace real estate markets for what the economy might look like post-pandemic. Just like few anticipated the mid-pandemic housing boom, nobody can really predict where interest rates will eventually land in the new normal.
For now, rates remain lower than ever, but will have to come back up at some point. Talk to your lender or broker about what this change means for you; their expertise will help you navigate the tricky waters ahead.
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