Canadian real estate markets may have got the first big cooling measure today. The Office of the Superintendent of Financial Institutions (OSFI) announced they are moving to tighten uninsured mortgage leverage. The organization that regulates Canada’s banks, eased the mortgage stress test last year. Now that it’s clear mortgages don’t need stimulus, they’re looking to reverse the test to pre-pandemic levels. The regulators giveth, and the regulators taketh away.
OSFI Proposes To Reverse Extra Pandemic Mortgage Leverage
OSFI proposed an increase to the benchmark rate used for the mortgage stress tests. Uninsured mortgages would see the current benchmark rise from 4.79% to 5.25%, setting a new floor for leverage. If the move successfully proceeds, it would reduce the current max mortgage drop by 5%. Not exactly earth-shattering, but it rolls people back to pre-pandemic levels.
What The Heck Is A Stress Test?
If that sounded totally foreign to you, let’s unpack the OSFI mortgage stress test. The test applies to uninsured mortgages at banks, and checks buyers against a higher qualifying rate. It’s a basic form of risk management to assess a borrower’s ability. In non-bankster, this does 3 big things to help the financial system:
- Lowers maximum mortgage leverage. This helps to prevent people from getting up to their neck in debt. When that happens, they become a higher default risk.
- Qualifies your ability to pay higher mortgage rates if credit conditions improve. When mortgage rates are near record lows, they likely won’t stay there. If you are tested at a higher mortgage rate, you’ll know you can handle any future increases.
- Protects the economy from over-allocation in housing. When interest rates are low, housing becomes attractive. Sometimes too attractive. A stress test allows cheap credit while preventing people from over-allocating.
How Is The Canadian Mortgage Stress Test Done?
Lenders test you against a contract or the benchmark rate — whichever is higher. The contract rate is the rate you’ll pay, plus 2 points to determine how you can handle a hike. The benchmark is the BoC 5-year fixed, which is currently 4.79%. Whichever is higher, is the number you are tested with.
Just to make it crystal clear, let’s go through a quick example. We’ll assume you have a household income of $100,000, and find a 5 year fixed rate mortgage at 2%, with a 25-year amortization. You’re not just good at your job, you’re also a great mortgage hunter.
Using no stress test, you would be able to borrow a maximum of $708,500, less servicing costs like property taxes. If you were stress-tested with 2 points added, that drops about 20% lower.
Except, in this case, 2 + 2 is less than 4.79%, so you’ll need to use the benchmark rate. Using the benchmark, the maximum mortgage is $526,600, before servicing costs. It’s about 4% lower than if the contract rate was used to determine the max.
Markets Change Faster Than People Expect
The jump from 2% to 4% might sound like a ridiculously fast climb, but a lot can happen in 5 years. From 2016 to 2019, Ratehub historical data shows the 5-year fixed-rate jumped 55%. Other risk factors include a deterioration in quality. Just because you qualified with the best rates, doesn’t mean you’ll renew with it. In a worst-case scenario, you most likely handle payments with ease. In a best-case scenario, you have more money to diversify your investments and spend on life.
The measures are currently proposed, so they aren’t final until the consultation. It’s hard to not see them going through since they’re just rolling back pandemic ease. This also comes after OSFI noted mortgage borrowers were over-leveraging once again. As well as banks asking the government to do something about this mortgage binge.
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