Canada’s Mortgage Stress Test: An Attack on Home Ownership?

Canada’s Mortgage Stress Test: An Attack on Home Ownership?

It’s been more than a year since mortgage stress test regulations were implemented in Canada. Home sales are down and economist Will Dunning says the rules will cause employment to drop by up to 200,000 jobs. Alberta’s new premier and other critics say it’s time to make some changes.

Before the recent provincial election in Alberta, United Conservative Party Leader Jason Kenney said that Canada’s mortgage stress test regulations are “an unfair attack on home ownership.”

He said, “One of the reasons why homes are less affordable in Alberta today is because of unfair rules imposed by Ottawa to deal with the overheated real estate markets in Toronto and Vancouver.” He said Alberta’s markets were not at risk of overheating, and the government “has taken out a bazooka rather than a fly swatter to deal with this problem.”

Kenney, who was elected premier, is one of many critics who are alarmed at the impact that the mortgage underwriting guidelines, known as B-20, had on the real estate market. Sales and mortgage originations are down across the country.

CIBC deputy chief economist Benjamin Tal says in a report that the value of new mortgages fell by $25 billion, or eight per cent, in 2018. He estimates that B-20 accounted for $13 billion to $15 billion of that total.

“B-20 was designed to improve the overall credit quality in the market,” Tal says. “And indeed, the share of high-quality mortgages in originations is currently at a record high of more than 52 per cent.” But he says the trend to improved quality was already underway by the time the guidelines were introduced.

“The 21 policy changes related to residential mortgage lending introduced by governments and regulators over the past decade played a significant role in improving overall credit quality in the Canadian market,” he says. “The point being that B-20 was introduced to an already healthy credit market.”

The stress test requires borrowers to qualify at a rate two percentage points higher than the rate being offered by their lender.

“The stress tests are concerned with mortgage borrowers’ ability to make payments once they renew their mortgages (which will usually occur in five years),” says economic consultant Will Dunning . “The tests include a low-probability event (that in five years interest rates will be two points higher) but ignore a high-probability event (that the borrower’s income will be at least 10 per cent higher). If future interest rates are indeed two points higher, that would be because the economy is very strong. In that case, it is extremely likely that there will be income growth, which will somewhat offset the higher future mortgage payments.”

Dunning says reduced housing activity creates a “negative housing wealth effect” that will have negative economic consequences. He says the stress tests “will cause employment in Canada to be at least 200,000 lower than it would otherwise be, once adjustments have fully occurred.”

Improving overall credit quality is a good thing, Tal says, but that’s not the whole story. The guidelines only apply to federally regulated lenders. Many borrowers who can’t pass the stress test are now turning to private lenders, who may be charging higher interest rates.

Tal says that in Ontario during the last two years, mortgage originations provided by alternative lenders rose by a cumulative 27 per cent, while originations in the market as a whole fell by 11 per cent.

“Alternative lending is an integral part of any normally functioning market,” Tal says. “But a fast-growing alternative lending market is not. Behind the scenes, there is a transfer of risk from the regulated to the less regulated segment of the market ñ from where there is light to where it’s dark.”

The Office of the Superintendent of Financial Institutions Canada (OFSI) is responsible for B-20. Recently assistant superintendent Carolyn Rogers addressed some of these issues at a speech in Toronto.

“The most common criticism is that we implemented a national policy to deal with a localized problem ñ that of extreme price escalation in the residential property market that only exists in Toronto and Vancouver,” she said. “This criticism assumes that B-20 was designed to target escalating house prices. Which it was not. B-20 was designed to target mortgage underwriting standards. And sound underwritings look the same no matter what city or province you live in; when interest rates rise, they will go up in Calgary and Winnipeg at the same time and by the same amount that they will go up in Vancouver and Toronto.”

Rogers said that borrowers turning to unregulated lenders to avoid the stress test “is a legitimate concern; this is a balance that all regulators must grapple with. But it cannot be a reason not to act, or not to do our job.”

She said, “The mortgage broker and the real estate industry are well placed to help manage this risk. If you see risks, if you think these options put your borrower in a vulnerable position, you can steer them away. That would be the right thing to do.”

The stress test does not apply to borrowers who renew their mortgages at the same lender where they have an existing mortgage. Critics say that results in decreased competition. In her speech, Rogers said OFSI has a tracking system in place to monitor rates. “To date we haven’t seen any evidence that banks are taking advantage of this situation to the detriment of borrowers.”

She added: “The escalating cost of homeownership in Canada, and its knock-on effects to the economy and to society is a problem. And it’s a problem that is proving very challenging to address. But the answer to this important problem cannot be more debt. Particularly, it cannot be more consumer debt, fuelled by lower underwriting standards.”

Tal admits that “the stress test imposed on the market was probably necessary, since there was a need to save some Canadian borrowers from themselves.”

But he says regulators should revisit B-20. “We need a more flexible benchmark, potentially a narrower spread over the contract rate when interest rates approach cyclical peak, and perhaps to establish a reasonable floor under which the qualifying rate will never drop below.”

Back in Alberta, one of Jason Kenney’s election promises was that he’ll introduce a motion in the legislature asking the federal government to exempt Alberta from the regulations, and inviting other provincial governments to do the same.


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