19 Apr

The Stressful Stress Test


Posted by: Griffin Gillis

If you have been keeping up with your real estate and mortgage news, I can only assume that you’re a mortgage nerd like myself!  The biggest headline is “Banking Regulators Planning to Increase Stress Test to 5.25% June 1st”. This increase isn’t a guarantee but it’s good to know how this might affect the housing market. For those of you that may be unfamiliar with the stress test and what this raise means, I’m happy to explain the interesting world of the stress test.

*I don’t go into extreme detail about stress tests in this blog to keep it short and informative. If you want to find out more please reach out.*

The stress test is the Bank of Canada’s way of preparing for the worst. They do this by making every individual qualify at a higher rate than they will actually be paying. Just in case someone loses their job or runs into a large amount of debt the Bank of Canada wants to make sure that Canadians can still make their monthly mortgage payments. For example, if your Dominion Lending Centre’s mortgage agent (hopefully me) sets you up with a 2.09% rate on a $500,000 mortgage, your monthly payments would be $1868. The Bank of Canada wants to make sure you can pay a 4.79% (current stress test) on that $500,000 mortgage, making mortgage payments of $2606. Remember; the rate you’re actually paying is the 2.09%, the 4.79% it is just simply an affordability calculation.

The big issue with the stress test is that although it forces Canadians to be financially responsible it also limits how much we can borrow. This is because your “monthly payments” are being qualified at a higher rate making your income more leveraged and lowering the amount a lender will loan. For example, before the stress test was created in 2018 Canadians making $80,000 a year with a 2.09% rate and 25 year amortization could afford a mortgage of $500,000. Now with the stress test and the exact same situation, Canadians can afford a mortgage of $400,000. This directly affects first time home buyers and individuals entering the market with smaller down payments because these groups need higher loan amounts to compete with people who have a lot of equity to invest.

*Numbers above are estimates and are based on assumptions about the client and the market situation*  

The Canadian government is now increasing the stress test from 4.79% to 5.25% lowering how much Canadians can qualify for once again. The goal of this is too cool down the housing market, which has shown huge increases in appreciation. If you’ve done your research, some experts believe this is a great idea and some believe it’s a waste of time. To be honest; it’s both a good and bad idea to raise the stress test.

Cooling down the housing market is a good thing as demand is far too high. The Canadian government needed to try something to slow down the housing market. This could slow down the housing market because it might discourage people from either entering the housing market or finding a new house because they won’t be able to compete in the purchase range that they want. Another positive is that we don’t know how the housing market is going to react once the pandemic is over. By raising the stress test the government is preparing Canadians for the worst just in case the rates go up once society returns to normal.

On the other hand, raising the stress test might have minimal to no affect on the housing market. First of all an increase of .46% (5.25 – 4.79) is not overly significant. If a Canadian could qualify for a $400,000 mortgage ($80,000 annual income and 25 year amortization) under the current stress test at 4.79 then they could qualify for a $380,000 mortgage under the new stress test at 5.25% in the exact same situation. I understand that twenty thousand dollars could be the difference maker but it’s probably not going to discourage enough buyers to cool down demand. If this stress test increase does lower prices in the housing market than it will only be by a minimal amount and not by hundreds of thousands of dollars. This will leave first time home buyers and individuals entering the market with smaller down payments in the exact some situation they were in before and continue to help the individuals who are already equity rich.

I didn’t give you an answer on whether the stress test increase is a good or bad thing and thats because it’s an answer that will reveal itself in the future. In the short term, it’s a minor policy change that will most likely not change the market in a significant way, however, if it forces Canadians to be more financially responsible then it could in fact be very valuable in the long term. This change is set to take place on June 1st so if you’re really concerned about getting qualified with the current stress test please reach out.  I’m happy to help!