Borrowers largely prepared for renewal shock thanks to test, argues advisor
It’s a measure that has frequently drawn the ire of the mortgage industry – but is the stress test finally due some praise?
That test requires borrowers to prove they can meet a qualifying rate of either 5.25% or their approved rate plus 2%, whichever is higher, when applying for a mortgage with a bank or other federally regulated lender.
During the COVID-19 pandemic, when interest rates hovered near record lows, it meant Canadians had to show they could absorb the potential impact of borrowing costs - in some cases significantly higher than what they would be paying at the time.
But with rates having shot up noticeably since that era, some believe the stress test has proven an effective instrument in preparing homeowners for the looming prospect of higher borrowing costs when they renew their mortgage.
Raphael Ambrozewicz (pictured top), an advisor with BlueShore Financial in Vancouver, told Canadian Mortgage Professional that even though borrowers aren’t stress tested when renewing with their existing lender, having to go through that process when first taking out their mortgages meant they could at least be confident they’d be able to stomach higher rates.
In the long run, he said, it’s served homeowners well. “It’s worked for fixed interest rate mortgages because if you were getting into a mortgage at 2% or many of them below 3%, but your payment was being stressed at [5.25%], people were prepared to do that,” he said.
“So if they were to be renewing their mortgage today at 5% and there’s no stress testing added to it, because you’re just renewing it… well, the 5% just very much might be here, and you still should be OK to make that payment.”
Of course, that will come as little comfort to new homebuyers, who are grappling with a stress test significantly higher than the rates they would have faced at the height of the COVID-19 pandemic.
Average rates have climbed above the 5.25% mark in recent years, meaning borrowers are now almost certain to be stress tested at a rate higher than 7.25% (their contract rate plus 2%).
How is the stress test impacting buyers in the current market?
A recent dip in mortgage rates has improved affordability marginally – but prospects of buying a home are still dim in many cities. Eight of 13 major markets included in Ratehub’s monthly affordability calculations require a six-figure income to purchase the average home, with Toronto and Vancouver homebuyers needing an income well above $200,000.
The Bank of Canada’s decision to lower interest rates for July 2024 has made it easier for Canadians to buy a new home as prices have become more affordable, says Ratehub’s July 2024 Affordability Report.
— Canadian Mortgage Professional Magazine (@CMPmagazine) August 21, 2024
Read more: https://t.co/J0ekZJJ32j#housingmarket #houseprices
Those Canadians lucky enough to own their own home may not be stress tested upon renewing with the same lender – but the fact that rates remain high means they’ll still be weighing up their options carefully, according to Ambrozewicz. “I think between now and 2026 it’s going to be fierce competition between financial institutions to retain existing mortgages,” he said.
“Clients, as high as interest rates will be, they’ll be doing a lot of shopping. Banks… will be as competitive with the interest rates [as possible] just to retain it, because it’s so much hardier and costlier to bring a new mortgage than retain an existing one.”
Could the stress test be scrapped?
In March, the Competition Bureau recommended that the stress test be scrapped for borrowers upon renewal, claiming it hinders their ability to shop around for a better rate with a different lender.
Current high rates, the Bureau suggested, could prevent homeowners from qualifying with another lender and give them little choice but to renew with their existing institution. “With the current high interest rates, some borrowers may be unable to stress test even though they have good credit and would have been able to service their loan,” its report claimed.
“When a borrower cannot switch to another lender, the current lender faces almost no competition and can offer higher rates to these captive borrowers without fear of losing their business.”
Canada’s banking regulator, the Office of the Superintendent of Financial Institutions (OSFI) has also recently acknowledged an “imbalance” in the stress test for borrowers when their renewal comes around.
Still, there appears little prospect of change on the horizon. “If you loosen one underwriting standard, you’d probably have to loosen more,” superintendent Peter Routledge told a parliamentary committee in June, “and our mandate calls for us to be fairly vigilant on this.”
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