OSFI has proposed new changes to the mortgage stress test in an effort to cool an overheated real estate market. Markets such as Toronto and Vancouver have been exploding over the past twelve months despite the pandemic. It brings the question of whether this will have the desired effect or will simply be a temporary solution to an ongoing problem.
The stress test was applied to uninsured mortgages in January 2018 by the Office of the Superintendent of Financial Institutions, OSFI. It was officially called the B-20 Guideline and was an attempt to cool down the country’s real estate market. The test was meant to discourage Canadian buyers from borrowing over their capacity at a time where the market was both incredibly attractive and highly competitive.
Under the stress tests, a borrower had to prove that they could comfortably afford a mortgage at a rate that was either 2% higher than the contracted rate or equal to the 5-year benchmark rate published by the Bank of Canada, whichever was higher. In 2018, that benchmark was 5.14%. If a lender offered an interest rate of 2%, you would have to demonstrate the ability to afford a mortgage at 5.14%. However, if you were offered a 3.2% mortgage, you would have to demonstrate the ability to afford a mortgage at 5.2%.
In 2018, the RBC calculated that the minimum income required for a buyer to purchase a $500,000 home would have to be $16,000 higher than prior to the introduction of B-20. This “impossible rise for many buyers” caused a lot of scrutiny. But the property market did cool after its introduction. Not before heating up for buyers to seize their chance before the cut off in January 2018. A huge flurry of activity and last-minute buying made late 2017 a nightmare for many buyers, all desperate to get in before it was too late.
The new changes proposed by OSFI, set to go into effect on June 1st, 2021, will require uninsured mortgages to prove they can afford their mortgage at an interest rate of 5.25% or 2% points more than their offered rate, whichever is higher. 5.25% from 4.79% may not seem like a huge jump but it’s an almost 50 basis points jump. It would make many buyers immediately qualify for significantly less. As an example, if a buyer qualified for a $1 million mortgage, the new stress test would shrink that borrowing capacity to $955,000.
This is devastating for many buyers, particularly first-time home buyers in competitive markets such as Vancouver and Toronto, who are already struggling to buy. Though, some real estate experts are saying that these changes wouldn’t have much of an impact on the rest of the population of buyers. The reaction to the changes was generally split into two factions: either the new stress test went too far or it wasn’t going far enough.
A 4-4.5% decrease in purchasing power may not affect many but it’s easily argued that such a change continues to propel markets such as Toronto into an impossibility for buyers who aren’t wealthy or have the opportunity to borrow from family. It is easy to see how such things will exacerbate the wealth gap we already see in Toronto’s real estate market. Some consider the new stress test and overreach as the current test already tests almost 300 basis points above many of the lowest uninsured mortgage rates available. It also fails to take into consideration repayment of mortgage principal and income growth of the borrowers in the future.
So what should be done instead? There’s no right answer and no golden solution. Surely if there was, we would have implemented it and solved this problem already. However, the increase for the stress test puts the burden of cooling the market on the buyer which ignores many other aspects of the market that drive the competition and heat. Cutting people out of the market like first time homebuyers will not solve the problem. Alternative solutions need to focus on what we see as common practices in the real estate market that have a direct impact on driving higher and higher pressure on market prices. Practices such as bidding wars and blind offers fuel the craze that drives up the price. We need to address these issues to properly and sustainably cool the real estate markets such as Toronto and Vancouver rather than shrinking the buyer pool. Speaking to our trusted mortgage agent Lesley Tenaglia, she believes a rate of 5.25% is high for a rate in 5 years. These kinds of rates only serve to hurt first-time home buyers or buyers with a lower income.