Mortgage stress test change – what's been the impact?

The beginning of June marked a year since changes to the mortgage qualifying “stress test” rate were introduced, with an eventful 12 months transpiring in the meantime.

That move – announced by the Office of the Superintendent of Financial Institutions (OSFI) for uninsured mortgages, and swiftly replicated by the federal Finance Ministry for their insured counterparts – saw the stress test rate rise to the greater of 5.25%, or the contract rate plus 2%.

Last year’s changes have been a contentious topic in the mortgage industry, with some at the time describing them as a largely symbolic move and others calling for the stress test to be scrapped entirely.

Still, a leading broker told Canadian Mortgage Professional that it had proven a prudent measure to ensure consumers can handle the challenges of potential rate increases since it was first introduced in 2018.

“There was tons of criticism of the stress test when it was first introduced,” said Frances Hinojosa (pictured top), chief executive officer and co-founder of Tribe Financial Group. “However, they say hindsight is 20/20.

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“As a whole, and considering what’s happened in the past few years, I’m certain that most people could say they’re grateful that we did have prudent underwriting parameters in place, that we didn’t completely damage the real estate market considering what we’re going through right now with rising interest rates and inflation.”

Read next: OSFI mulls further stress test changes

Borrowers who have seen their rates increase should theoretically still be protected from the financial impact of those hikes because they were tested at a higher rate than their mortgage at the time. That’s a testament to the effectiveness of the stress test, Hinojosa said.

“A lot of clients back in the day were getting stress tested at rates even as low as 4.95% to 5.25% in the five-year fixed – rates have already surpassed that threshold,” she said. “From a banking standpoint, the debt levels are actually insulated right now because the consumer should still be able to afford those payments based on their original stress test, even in this rising-rate environment.”

The stress test, and changes announced last year, may not have come as a welcome development for borrowers or those interested in purchasing a home in Canada who suddenly saw a drop in the mortgage amount they could qualify for.

Still, it’s become such a widely accepted part of the mortgage process that it’s no longer even a talking point among customers, according to Hinojosa, who said anyone who wants to buy a home is largely aware of the need to qualify under stress test rules.

Since the rule change, fixed rate mortgages have climbed steadily, meaning the 5.25% figure is now usually irrelevant for borrowers who choose a fixed option, and OSFI’s Ben Gully left the door open last month for potential further tweaks to the stress test.

The deputy superintendent of supervision said although the regulator usually revisits the qualifying rate on a yearly basis, it also “reserve[s] the option to come back more frequently than annually” if a change was required.

“We’re continually reviewing it, their applicability and, if conditions warrant, we would obviously move off-cycle to address them,” he told reporters in May.

Read next: Industry leaders weigh in on stress test hike

Hinojosa said she believed regulators would watch the trajectory of the market closely before deciding whether to introduce rule changes on the stress test – although she said they seemed more likely than not in the long term, especially because of the current discrepancy between qualifying rules for fixed and variable mortgages.

“I believe that there haven’t been any changes yet to the stress test because the regulators and the government are just watching to see what happens with the housing market right now, between inflation, rising interest rates and the bond yields rising,” she said.

“Are those measures going to cool the market on their own or does change have to be made? I don’t feel they’re going to change the stress test necessarily yet – but I do anticipate it to be on the horizon.”

Brokers also need to keep in mind that they have a fiduciary duty to their clients to ensure they can afford their mortgage, she said, and that the stress test is in place to maintain the soundness and stability of Canada’s overall financial system.

“No-one likes to have to qualify at a higher parameter, but I think we have to appreciate and understand these [rules] are put in place to ensure that our market is well insulated and doesn’t see risk or damage in the future,” she said. “Prudent underwriting is not there to prevent homeowners – it’s there to protect homeowners.”