Over the last few weeks, there have been a number of articles and discussions about the impact of the new rules for qualifying for mortgages, commonly referred to as the stress test. Some commentators, myself included, have indicated that with the already cooling housing market and mortgage rates up 75 basis points, it may be time to have a discussion as to whether the test needs to be adjusted.
The test, which came into effect in 2018, was intended to protect consumers by limiting the amount of money they could borrow for a new home. It means that all home purchasers must qualify under the Bank of Canada Benchmark five-year rate (5.34 per cent) or the rate offered by the lender plus 200 basis points (two per cent). As a net impact, an average Canadian looking to purchase a home with a 20 per cent down payment will see approximately a 20 per cent decline in how much they are approved to borrow.
What does this mean for consumers? First and foremost, people who would have previously been able to afford their preferred home are not able to do so. In fact, last summer, a study by Mortgage Professionals Canada concluded that 18 per cent of buyers could not pass the stress test despite being able to afford their preferred home.
This has two potential impacts. Some prospective buyers remain renters for a longer time period, contributing to higher rents and lower vacancy rates across the region. There is market evidence for this – in 2018, single-family homes had the lowest annual sales in the last 20 years. Although part of the reason for this decline is the normal market cycle, there can be no doubt that the stress test artificially dampened demand.
Other prospective buyers adjust their expectations and purchase a condo they can qualify for instead of the house they really want. That has its own impact on the housing market – witness the continued performance of the condo market in 2018, as condominiums increasingly fulfill the role that was in the past performed by the traditional suburban starter home.
Another key impact is that the stress test prevents people from entering the property ladder and generating equity in their own home. All debt is not created equal and borrowing money to purchase a home is vastly different from racking up consumer debt to purchase consumables. Wealth creation through property ownership has a proven track record in Canada.
Artificially limiting individuals’ ability to acquire property, and in fact eroding existing homeowners’ wealth by rapidly cooling key property markets, should be as much of a policy concern for governments and regulators, as protecting consumers from levels of interest rates that may never come. Additionally, we should not forget that first-time entrants on the property ladder are often young, at a period of their lives where they are progressing in their careers and experiencing salary growth, with many working years ahead of them.
Do we need to protect consumers? The answer is and will continue to be yes. Has the stress test worked? The answer is yes, but maybe it has overshot its target. Conditions have changed and now is the time to have a discussion on the test and its impact before more long-lasting damage is inflicted and the economy starts to suffer.
The Canadian Home Builders’ Association has put forward two recommendations that we believe Ottawa should implement as part of this spring’s budget: Reintroducing 30-year amortization periods for first-time buyers and adjusting the stress test now that interest rates have risen.