At the end of 2019, Canadian Prime Minister Justin Trudeau asked Finance Minister Bill Morneau to consider reviewing the mortgage stress test. The public words were “Review and consider recommendations from financial agencies related to making the borrower stress test more dynamic”. I had a few questions on these comments that I know I’ll never get the answer to, such as: What does “more dynamic” really mean? According to the dictionary, dynamic as an adjective can be used in 2 ways:
- (of a process or system) characterized by constant change, activity, or progress.
- (of a person) positive in attitude and full of energy and new ideas.
I’m assuming dynamic refers to the first point above. So does that mean we are going to change the stress test constantly?
Another question I had was: Which financial agencies is Bill Moreanu taking recommendations from? The banks? The government? Bank of Canada? CMHC? Office of the Superintendent of Financial Institutions (OSFI)? The source of the recommendation matters because each of those financial bodies has their own agenda, goals and underlying objectives.
One thing is for certain – the news of reviewing the stress test has gotten many people in the lending world very excited. It’s almost as if everybody is expecting the stress test to be removed or made “less stressful”. However, all of this sounds like political jargon to me.
The Political Possibilities – Regardless, this affects the “dynamics” of the market and it has a lot of people talking about what changes could be made. There are so many levels that I could take a deep dive into on this matter. I could probably write 2,000+ words on this topic but I’ll keep it short and sweet with 2 key topics of discussion at hand.
- Changing the Stress Test Percentage – The stress test is based on an interest rate of 5.19% right now, which is the Bank of Canada’s 5-year benchmark. The major discussion point right now is to potentially reduce this rate by 1%. If this happens, then the availability of credit increases by approximately 10% (i.e., you could borrow 10% more).
- Why this may not happen: The Schedule A banks (i.e., TD, CIBC, etc.) are highly motivated to keep this benchmark high for their own profit margins. A higher stress test interest rate means that more people are locked into existing mortgages with higher rates because they can’t re-qualify under the stress test to a different lender. Ultimately, this means that when mortgages are up for renewal, the homeowner must take whatever rate their existing banks give them otherwise they become homeless (i.e., they can’t re-qualify under the stress test with a different lender).
- Increasing the Amortization Period Back to 30 Years – As of right now, only buyers with 20% down are able to qualify for a 30-year amortization period. This is important because a 30-year amortization means that you are paying less each month over a longer period, which ultimately allows you to borrow more money. You’re tested on how much of your income goes into repaying your loans. If your monthly loan payment is less, then you could borrow more. Note that if amortization is increased to 30 years, that’s approximately an increase of 10% in available credit.
- Why this may not happen: This makes no sense. If they allow buyers with less than 20% down payment to get a 30-year amortization, it defeats the very purpose of the stress test. The stress test was designed to prevent home buyers from overextending themselves when purchasing a home but if buyers are able to borrow more with less down payment, then it goes against that design. That just seems hypocritical. Starting from the early 2000’s, the mandate has always been to reduce the amortization period. We went from 40 years to 25 years and now we’re trying to increase it back to 30 years. Either make up your mind or stop intervening with the free market!
Mixed Messaging – It seems like they are making the rules too “dynamic” by constantly changing it. All of these “potential revisions” look like they are targeting the first-time home buyer segment of the population – the Millennials, who are having a difficult time getting into the market in Toronto and Vancouver. I don’t hear affordability issues coming from other Canadian cities. Is it a coincidence that Toronto and Vancouver is where the majority of Trudeau’s votes came from? Maybe… but I won’t go there.
There have already been other incentives for first-time homebuyers that were implemented, such as the new CMHC “interest-free loan” to buy a home and increasing the first-time home buyer RRSP withdrawal limit. These incentives go against the purpose of the stress test. As you know, the government wants to make sure Canadians, especially first-time home buyers, are financially responsible by having the stress test to reduce the amount money they can borrow to buy a house. However, at the same time, the government is giving them an interest-free loan and are allowing them to borrow from their retirement funds to buy a house. By now, are you as confused as I am with all of these government policies and incentives floating around?!
The Wrap – Like I said earlier, I could probably write more than thousand more words on this topic but I won’t digress. Even if I did write more on this topic, I don’t have the answers. All I see are problems with these band-aid solutions, and no “real” plan to move forward (cue: the ongoing Gardiner Expressway mess). My only suggestion to Mr. Trudeau is to really look at the supply issue that we have on hand. Perhaps make it easier for Builders to develop? Enforce less Builder delays? Lower taxes? Either way, I won’t look at this “dynamic review” of the stress test as a saving grace to the rising affordability crisis that we have in Toronto.
Until Next Time, Happy Real Estate-ing,