Housing analyst suggests current policies may do more harm than good
Canada's stringent mortgage stress tests cause “more harm than good,” according to Toronto-based consulting economist Will Dunning.
Dunning argued that the tests prevent many Canadians from making advantageous housing choices and have worsened the Canadian housing supply crisis.
“The design failures in the mortgage stress tests mean that large numbers of Canadians are being prevented from making housing choices that they believe are in their best interests,” Dunning told The Globe and Mail. “In this respect, the mortgage stress tests are making us collectively worse off.”
Dunning's analysis suggests that the cumulative impact of mortgage regulation changes since 2012 has resulted in a 10% decrease in resale home purchases, potentially translating to hundreds of thousands of lost sales. This has also contributed, in his estimation, to a 200,000-unit reduction in new housing starts, further exacerbating Canada's housing supply crisis.
Testing without income growth
The stress tests require new mortgage borrowers to qualify at a rate 2% higher than the actual contracted interest rate. For example, lenders must test a new mortgage at 7.5% despite a typical current rate of 5.5%.
However, the testing failed to consider income growth, which can impact a borrower’s ability to sustain mortgage payments.
"The testing fails to consider an important factor that will determine future outcomes for borrowers: that their incomes will increase," Dunning stated, noting that neither the Office of the Superintendent of Financial Institutions (OSFI) nor the Canada Mortgage and Housing Corp (CMHC) has publicly acknowledged or addressed this issue.
Despite sharp interest rate increases over the past two years, the number of Canadians experiencing mortgage difficulties has barely moved. As of December, only 0.18% of borrowers were behind on their payments by three or more months, according to the Canadian Bankers Association.
"The continued low arrears rate doesn't prove the mortgage stress tests are working. Instead, it demonstrates that the stress tests need to incorporate income growth," Dunning explained, providing data showing that while a typical mortgage renewal results in a 20.4% payment increase, borrowers' incomes have increased by 22.3%, making the new payment more affordable.
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Dunning suggests using an increment of 0.75 points above the contracted rate to adequately simulate a two-point rise in the mortgage rate over five years when accounting for income growth.
Focusing on the wrong risk
Mortgage stress tests target the wrong type of risk, according to Dunning.
Relying solely on interest rate fluctuations as a predictor of mortgage defaults is inaccurate. He said that historical data and statistical analysis clearly indicate that changes in mortgage rates have minimal impact on arrears. Job loss or other income reductions are the primary drivers of loan defaults.
"The arrears rate remains extremely low because the employment situation in Canada is still very strong and because incomes continue to grow," Dunning said.
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