Rethinking the Mortgage Stress Test

The fundamental premise of the stress tests, was intended to determine the debt worthiness of borrowers in case interest rates were to rise in the future. Mortgage defaults, the MPC argues, are influenced more by increases in job losses and not necessarily by changes in interest rates.

Housing sales in 2018 declined by 11 per cent, but the amount of outstanding mortgage credit at the end of 2018 was estimated to be a staggering $1.55 trillion.

While the decline in sales has adversely impacted mortgage brokerages and lenders, the MPC report suggests the effect on the larger economy could include many unintended consequences.

The stress tests require borrowers, both first-time home buyers and those applying for in-transfer of existing mortgages, to qualify at a rate two percentage points higher than the contracted rate. However, the report argues the threshold is unduly high and ignores the fact that in five years, a borrower’s income would be higher and they would have paid a significant amount towards the principal.

If the average wage increase in Canada is about two per cent, in five years, a typical borrower’s income would be more than 10 per cent higher than today. Furthermore, in five years, the borrowers would have made a “substantial amount of principal repayment” — as much as 13 to 14 per cent in typical circumstances.

The stress test should account for higher incomes and reduced principal amount five years down the road. Thus, if one needed to test whether a borrower could service the debt if interest rates were to rise by two percentage points five years later, “a rate that is 0.75 points higher than the initial contracted rate” should have sufficed today.

Mortgage Professionals Canada (MPC) questions whether government interventions in the mortgage market have been too intrusive and could lead to further unintended economic outcomes. The consequences of a slowdown in housing markets affect the entire economy, including jobs in real estate and construction as well as the revenue generated by land-transfer and other related taxes. The unintended consequences, such as the increase in the demand for rental housing, are also numerous.