Will Canada’s Stress Tests Actually Work?
By Ryan Goldsman, CFP®, PAIP®
In 2016, Canada’s introduced the “stress test” for all new insured mortgages. In 2018, it was expanded to include all non-insured mortgages. Without a doubt, the “safety first” approach was a good intention to guard the housing market from a systematic collapse, but the question remains if it was actually needed.
In 2015, a 5-year fixed rate mortgage was available for less than 3% which was starting to become the new “normal” as interest rates were at historic lows. Barring a decline in total population and deflation, rates had nowhere to go but up. If new borrowers were to renew their mortgages at the end of their current term, the regulators wanted to proactively ensure that the average borrower could afford higher interest rates. Without a doubt there was an effort to avoid a systematic housing collapse across the country – whenever higher interest rates would make their appearance.
If too many Canadians are not able to afford higher rates, then many homes would have to be sold, or potentially refinanced with longer amortization periods. What regulators may have missed is that over a 5-year period, employees typically obtain salary increases which leads to higher disposable income over that timeframe. Arguably the stress test wasn’t needed at all. As the income of average Canadians increased, they would be able to afford higher interest rates. On the other side of the coin, the stress test kept many willing buyers out of the housing market; their total wealth continued to lag the average wealth of most Canadian homeowners.
As we’re now facing higher mortgage rates and many mortgage terms are coming up for renewal, it’s time to “pay the piper”. Those who were stress tested now have a choice to make: assume the higher mortgage rates, extend their amortization periods, or sell their home.
For every person who assumes a higher rate of interest, then the introduction of the stress test was justified. For each person who extends their amortization or sells their home, then it clearly wasn’t the correct approach. Time will tell.
As is often the case, where the most damage may have been felt is not in the error of commission, but in the error of omission. By introducing the stress test, too many Canadians who would have been able to afford a mortgage since 2016 have been left out of the market, and it’s one that’s performed extremely well. In many cases, these were highly educated, disciplined savers who were at the early stages of their careers. They’ve received many raises in excess of inflation, and even in excess of the average increase in home prices, but they’re still kept out of the market. As they earn higher incomes, housing continues to increase. Why not eliminate the stress test altogether?