The notion that more stringent qualifying requirements will provide the stability needed to handle an inevitable rise in interest rates and slow down an unsustainable housing market is a story that is easy to tell. Low interest rates, skyrocketing real estate markets and a continuing increase in debt-to-income ratios fuel the perceived need to slow things down, reduce borrowing power and, frankly, check ourselves before we wreck ourselves. The latest solution – the B-20 stress test – has been rolling for well over a year and is failing on three fronts.
First, the policy is disproportionately impacting smaller markets by painting the entire housing market with the same brush. Yes, the GTA and GVA make up most of the real estate in Canada, but an attempt to slow down these markets with policy that governs the entire country is fundamentally flawed.
For example, Alberta continues to feel the pain of a weakened economy. Housing is stable, but prices are down and inventory is still high. With low job creation in the province, fewer potential buyers are looking to enter the market. The last thing Alberta needs is a tougher barrier for entry into homeownership. Alberta wasn’t in the middle of a hot real estate market in the first place.
The same story can be told in parts of BC, the rest of the Prairies, and many parts of Ontario, Quebec and Atlantic Canada. Macro national housing policy is easy to implement, but it misses the fact that real estate markets are extremely micro. Further, it doesn’t solve the problem.
The hot markets have remained quite strong; Vancouver has seen a bigger drop, but this is likely due to the layering of multiple policy changes, both provincially and federally. What the policy has done more than slow down hot markets is push people into alternative lending options. Private lenders and MICs have seen record growth over the past 18 months.
Another problem is that the current stress test – at the greater of 200 basis points over the contract rate or the qualifying rate (currently 5.34%) – is simply too high of a number. The test reduces potential buying power by about 18%, and it can be argued that it does not need to be this much.
We are overshooting the impact of potential rate increases. In fact, with today’s stress test, we are accounting for almost a doubling of rates. As recently as April 2019, CIBC Capital Markets deputy chief economist Benjamin Tal questioned this number and suggested a rethinking of the stress test. Much lobbying has been done by Mortgage Professionals Canada and others to have this number cut in half.
The bigger issue is that, fundamentally, the policy in its current state is not dynamic and cannot pivot quickly enough. It’s not surprising that a regulatory policy isn’t fluid, but the trouble is that rate markets are. Last year, a potential buyer would have been looking at five-year fixed rates of 3.50% and qualifying close to 2% higher via the stress test. The same buyer today would be looking at a much lower rate of about 2.70% but still qualifying at 5.34%, or 2.64% above their contract rate.
The easiest solution is to not use an arbitrary qualifying rate as a minimum and instead simply add onto the contract rate. An equalling of the playing field, whether the mortgage is insured, insurable or uninsurable, would at least have all borrowers today qualifying at 4.70% instead of 5.34%.
The higher qualifying rate is concerning because lenders that use this posted rate when calculating payout penalties and have no interest in decreasing it when rates drop. The larger discount they provide, the more runway they have to charge a larger penalty should the mortgage be broken mid-term. Over the last six months, we have seen rates drop by close to 1%, yet the qualifying rate or posted rate has remained unchanged. This opens up the potential for record-high payout penalty costs.
Perhaps we should turn the stress test on its head and put a stress test on lenders’ posted rates – namely, a posted rate cannot exceed 200 basis points above the discounted rate offered.
Joe Jacobs has been a mortgage broker since 2004 and is a partner with Mortgage Connection. He is a regular commentator for outlets such as MoneySense magazine, the Calgary Herald and BNN.