As you may have heard, on January 1st of 2018, the Office of the Superintendent of Financial Institutions Canada (OSFI) instituted new policies to help curb what they believed to be a growing crisis of household debt across the country. One of the new rules is a mandatory “Mortgage Stress Test”. Originally, stress tests were reserved for high-ratio mortgages (ones with less than 20% down), or a mortgage term of less than 5 years. However, under the rules that went into effect last January, ALL new mortgage applicants must now complete a stress test before having their mortgage approved.
What Is a Mortgage Stress Test?
Quite simply, a mortgage stress test is a tool that helps determine if you and your family will be able to afford their mortgage over the long term. Most probably remember the ravaging effects of the 2008 housing crisis in the United States, much of which was caused by homeowners being locked into mortgages that they ultimately could not afford. Housing prices plummeted, peoples’ homes were underwater, and foreclosures went through the roof, trigging a massive financial meltdown.
Concerned that Canada could be heading for a similar fate, mortgage stress tests are used to ensure Canadians are not approved for homes and mortgages they ultimately cannot afford.
How Do Mortgage Stress Tests Work?
A mortgage stress test looks at your family’s financials, including all sources of income, assets, savings and more. Then, the test will analyze what would happen if there were to be a sudden shift in your financial health – for example, loss of employment, major medical expense, or rising mortgage payment. The idea is to understand just how much you could afford to pay monthly before you risk default, even in the direst of circumstances.
After looking at all your financial considerations, your mortgage application is run against the Bank of Canada 5-Year Conventional Mortgage Rate (currently at 5.34%), even if you were approved at a much lower rate. The idea being that if you run the mortgage against the higher number, you’ll end up with a “financial buffer” in case your financial situation changes.
Mortgage Stress Test Examples
Say you family has an annual income of $100,000. You’ve applied for a fixed-rate 5-year mortgage and have been approved at a rate of 2.83% – two and a half points below the current Bank of Canada rate of 5.34%. With a 25-year amortization period and a 20% down payment, before regulations went into effect, you would have been able to afford a home that was valued around $725,000. However now, with the mortgage stress testing your financials against the 5.34% rate, the value of the home you can afford has dropped to roughly $560,000.
While there are many variables that go into the mortgage stress test – including down payment, taxes, utilities, car payment, other debt payments, credit cards and more – the end result is the same: since the new regulations have gone into effect, Canadians applying for new mortgages are getting approved for significantly smaller loans.
(Special thanks to Loans Canada for putting together these great examples)
What Does This Mean for Buyers and Sellers?
With smaller loans being approved, both buyers and sellers are feeling the strain caused by the new regulations from OSFI.
From the buyer’s perspective, it means that the pool of available homes has now decreased significantly, with many of the previously desired homes now priced out of their budget. This leaves buyers with two options: 1. Refine their search, and begin looking for homes in a different price bracket, or 2. Wait to move until there is a change in their financial situation.
By waiting for a change (raise at work, paying down debt, selling a car, etc.), they will be able to (ideally), achieve a higher level of home affordability. However, this can be a dangerous game to play, as the mortgage stress test is based on the Bank of Canada 5-Year Conventional Mortgage Rate – and if this rate moves in an unfavorable manner, their mortgage stress test might get worse, even if their financial situation improves.
With all the uncertainty on the buyer side, sellers are feeling the heat as well. Many families that would have been considered potential buyers before the regulations are now unable to secure the proper loan, which limits the overall pool of buyers. Fewer buyers can create longer listing periods, and ultimately, drive down sale prices.
How is this Affecting the British Columbia Housing Market?
This drastic change in home affordability and mortgage approvals has already had a dramatic effect on the housing industry in British Columbia. In fact, according to the British Columbia Real Estate Association (BCREA), total home sales in the province dropped 24.5% in 2018, the first full year that regulations went into effect. The total sales dollar volume also saw a sharp decline at 24.2%.
BCREA Chief Economist Cameron Muir had this to say about the change: “BC home sales fell below the 10-year average of 84,800 units in 2018. The sharp decline in affordability caused by the B20 mortgage stress test is largely to blame for decline in consumer demand last year.”
Into 2019, sales and volume are continuing to drop, with March 2019 seeing 23% and 27.1% decline in total unit sales and sales dollar volume, respectively. Ultimately, this speaks to would-be buyers holding off on new home purchases until their mortgage situation improves.
How Can I Stress Test My Own Mortgage?
While there are many complexities to the process of running your own mortgage stress test, the Canadian Mortgage and Housing Corporate has a handy tool on their website to help you run a basic test, and get a general understanding of just how much house you’ll be approved for:
https://www.cmhc-schl.gc.ca/en/finance-and-investing/mortgage-loan-insurance/homebuying-calculators/affordability-calculator
What Does This Mean for Me?
The Canadian Mortgage Stress Test regulations have created significant challenges for buyers and sellers. While the intention is good – avoiding a financial crisis by loading up people with debt they ultimately cannot afford – the day-to-day result is frustration in the real estate market.
There are several steps both buyers and sellers can take to improve the outcome of their purchase/sale during this interesting time in the marketplace. With years of experience in the British Columbia real estate market, I have a unique understanding of how the regulations are affecting the sale of homes in this area, and can show you the exact steps you need to take to achieve a positive outcome.
Please contact me today so I can walk you through the specifics, and so we can build a plan that works for you!