The Canadian mortgage stress test, a policy implemented in 2018 to safeguard borrowers and the financial system against potential interest rate shocks, has been a subject of intense debate and scrutiny since its inception. While lauded for promoting responsible lending and mitigating risks, the stress test has also sparked significant criticism for its potential to hinder homeownership dreams, particularly for first-time buyers and those with lower incomes.
As we navigate the complex economic landscape of 2024, the future of the stress test has become a focal point of discussion. With interest rates on the rise and affordability concerns mounting, the question of whether the test should be maintained, modified, or even abolished has taken center stage.
Understanding the Mortgage Stress Test
The mortgage stress test is a critical regulatory measure designed to assess a borrower’s ability to manage mortgage payments in the face of potential interest rate increases. It works by evaluating whether a borrower can comfortably handle payments at a higher qualifying rate, which is determined in two ways:
- The Bank of Canada’s Five-Year Benchmark Rate: This rate is a key indicator of the overall interest rate in Canada. Lenders must ensure borrowers can afford payments at this benchmark rate, even if their actual mortgage rate is lower.
- Contract Rate Plus 2%: In some cases, the lender may use a qualifying rate that is 2% higher than the actual contract rate offered to the borrower. This additional buffer provides an extra layer of protection against potential rate hikes during the mortgage term.
The Impact of the Stress Test: A Multi-Faceted Analysis
The introduction of the stress test in 2018 had a profound and multifaceted impact on the Canadian housing market:
- Lower Mortgage Approvals:
- The most immediate and noticeable effect was a decline in mortgage approvals. According to Statistics Canada, mortgage approvals fell by 13.8% in the first quarter of 2018 compared to the previous quarter.
- This decline was particularly pronounced among first-time homebuyers, who often have lower incomes and smaller down payments.
- The stress test essentially raised the bar for qualification, leaving some borrowers unable to secure the financing they needed to purchase a home.
- Smaller Loans:
- Even for borrowers who managed to pass the stress test, the impact was felt in the form of smaller loan amounts. With the requirement to qualify at a higher rate, borrowers were often approved for less than they would have been without the test.
- A study by the Bank of Canada estimated that the stress test reduced the average loan amount by about 15%. This meant that many buyers had to adjust their expectations and settle for smaller homes or less desirable locations.
- Shift in Buyer Behavior:
- The stress test also triggered a shift in buyer behaviour. Some first-time buyers, faced with the prospect of smaller loans and higher qualification hurdles, opted to delay their homeownership plans altogether.
- Others chose to explore alternative housing options, such as renting or purchasing smaller condos.
- The test also incentivized some buyers to save larger down payments to offset the impact of the higher qualifying rate.
Impact of Stress Test on Mortgage Affordability
| Year | Average House Price | Stress Test Rate | Maximum Mortgage Amount |
| 2017 (Pre-Stress Test) | $511,000 | N/A | $408,800 (assuming 20% down payment) |
| 2018 (Post-Stress Test) | $496,500 | 5.34% | $347,550 (assuming 20% down payment) |
As evident from the table, the maximum mortgage amount a borrower could qualify for decreased significantly after the stress test was implemented. This reduction in borrowing power had a direct impact on affordability and the overall dynamics of the housing market.
Mortgage Stress Test Statistics (2018 – 2024)
| Year | Qualifying Rate | Average Home Price | Average Mortgage Amount |
| 2018 | 5.34% | $496,500 | $397,200 |
| 2019 | 5.19% | $508,600 | $406,880 |
| 2020 | 5.04% | $568,700 | $454,960 |
| 2021 | 5.25% | $686,600 | $549,280 |
| 2022 | 5.25% | $706,300 | $565,040 |
| 2023 | 5.25% | $669,800 | $535,840 |
| 2024 | 5.25% (No change as of Aug 2024) | $685,000 | $548,000 |
What’s New, What’s Not: The 2024 Mortgage Stress Test in a Nutshell
What’s Staying the Same?
1) No More Minimum Qualifying Rate (MQR):
As of June 1st, 2023, the Office of the Superintendent of Financial Institutions (OSFI) removed the minimum qualifying rate (MQR). Now, all borrowers are stress-tested at their contract rate plus 2%. This change was made because most contract rates were already higher than the previous MQR of 5.25%.
2) Stress Test Applies to Most:
The stress test still applies to all borrowers, whether they are applying for a new mortgage or switching lenders upon renewal. The only exceptions are:
- Renewing with the Same Lender: If you renew your mortgage with your existing lender, you typically won’t be subject to a new stress test.
- High-Ratio Borrowers Switching Lenders (New in 2024): As of January 1, 2024, borrowers with insured mortgages (less than 20% down payment) can switch lenders at renewal without being stress tested again, as long as the mortgage amount and amortization period don’t change.
Proposed Changes
| Change | Current Status | Potential Impact |
| Loan-to-Income (LTI) Ratio Cap | Proposed | This could further restrict borrowing capacity for some. |
| Gross Debt Service (GDS) and Total Debt Service (TDS) Ratios | Unchanged | No changes to existing affordability calculations. |
| Exemption for High-Ratio Borrowers at Renewal | Approved, Effective Jan 1 | May encourage switching lenders for better rates. |
- Loan-to-Income (LTI) Ratio Cap: This proposal aims to limit the total debt a borrower can carry relative to their income. It could further restrict borrowing power, particularly for those with high debt levels.
- Exemption for High-Ratio Borrowers at Renewal: This change allows borrowers with insured mortgages (less than 20% down payment) to switch lenders at renewal without undergoing a new stress test, provided the mortgage amount and amortization remain the same. This could increase competition among lenders and potentially lead to better rates for borrowers.
A Spectrum of Expert Opinions on the Canadian Mortgage Stress Test
Supporters:
- Protecting Borrowers and the Financial System: This camp argues that the stress test is a crucial safeguard against excessive borrowing and potential financial instability. They point to the 2008 financial crisis in the United States, where lax lending standards contributed to a housing bubble and subsequent crash. By ensuring borrowers can handle higher interest rates, the stress test helps prevent widespread defaults and protects the broader economy.
- Evidence of Effectiveness: Supporters cite data showing that the stress test has contributed to a more resilient housing market in Canada. Delinquency rates on mortgages remain low, and the overall financial health of borrowers appears to be stronger. They argue that the test has successfully filtered out borrowers who might have been vulnerable to financial shocks.
- Managing Household Debt: Canada has one of the highest household debt-to-income ratios among developed countries. Supporters of the stress test believe it plays a crucial role in curbing this trend by preventing borrowers from taking on unsustainable debt levels.
Critics:
- A barrier to Homeownership: Critics argue that the stress test is overly restrictive and unnecessarily hinders access to homeownership, especially for first-time buyers and those with lower incomes. They point to the fact that the test requires borrowers to qualify at a higher interest rate than they will pay, effectively reducing their purchasing power.
- Impact on Affordability: The stress test has been cited as a contributing factor to the affordability crisis in some of Canada’s major housing markets, such as Toronto and Vancouver. By limiting the amount borrowers can borrow, the test pushes home prices further out of reach for many Canadians.
- One-Size-Fits-All Approach: Critics argue that the stress test is a blunt instrument that doesn’t account for individual circumstances and risk profiles. They suggest that a more tailored approach, considering factors such as income stability, credit history, and savings, would be more effective in protecting borrowers without unduly restricting access to homeownership.
Neutral:
- Potential for Refinement: This group acknowledges the merits of the stress test in promoting financial stability and protecting borrowers. However, they believe it could be refined to strike a better balance between risk mitigation and affordability. They suggest exploring options such as:
- Adjusting the Qualifying Rate: Lowering the qualifying rate slightly could increase borrowing power for some buyers without significantly increasing risk.
- Targeted Exemptions: Exempting certain borrower groups, such as first-time buyers or those with high incomes but limited credit history, could improve access to homeownership for those who pose a lower risk of default.
- Alternative Measures: Exploring alternative risk mitigation tools, such as stricter debt-to-income (DTI) ratio limits or higher down payment requirements, could provide more flexibility while still ensuring financial stability.
What Does This Mean for You?
The mortgage stress test is a complex issue with no easy answers. While it plays a vital role in protecting borrowers and the financial system, it also poses challenges for those trying to enter the housing market. As the debate continues, it’s important to stay informed about potential changes to the stress test and seek expert advice to navigate the Canadian real estate landscape in 2024 and beyond.
| If You’re a Buyer | If You’re a Seller |
| Prepare for the Stress Test: Understand the qualifying rate and how it impacts your borrowing capacity. Use online calculators or consult a mortgage professional to get a realistic assessment of your budget. | Realistic Pricing: Set a competitive price for your home, taking into account that buyers’ budgets may be constrained by the stress test. |
| Explore Options: Research government programs and incentives that may be available to first-time buyers, such as the First-Time Home Buyer Incentive (FTHBI), which can help with your down payment. | Highlight Affordability: Emphasize features that appeal to budget-conscious buyers, such as energy efficiency, low maintenance costs, or proximity to public transportation. |
| Consider Alternatives: If you’re struggling to meet the stress test requirements, consider exploring alternative housing options, such as renting or purchasing a smaller home or condo. | Be Patient: The stress test has contributed to a slower market in some regions. Be prepared for a longer selling process and be open to negotiation. |
Mortgage Calculator:
Understanding your budget is crucial when considering a mortgage, especially in the current Canadian market with the stress test. Pegasus Mortgage Lending’s Mortgage Affordability Calculator can be a helpful starting point to assess your potential borrowing power. By inputting your financial details, you can get a realistic estimate of how much you might qualify for, helping you make informed decisions about your home purchase.
It takes into account several key financial factors:
- Loan Amount: This is the estimated amount you plan to borrow for your mortgage.
- Down Payment: The amount of money you’re putting towards the purchase of the home upfront.
- Annual Interest Rate: The current interest rate you expect to pay on your mortgage.
- Amortization Period: The total length of time you plan to take to repay your mortgage.
- Monthly Expenses: Your estimated monthly costs for things like property taxes, utilities, condo fees, etc.
- Monthly Debts: Your current monthly debt payments, such as car loans, credit card payments, or student loans.
How Does It Work?
Once you input these details, the calculator crunches the numbers to provide you with an estimated maximum loan amount you may qualify for. This is based on the information you provided and takes into account factors like your debt-to-income ratios (GDS and TDS), which are important for lenders to assess your ability to manage a mortgage.
Limitations
Keep in mind that this calculator only provides an estimate. Your actual borrowing capacity may differ based on your credit history, employment situation, and other factors. It’s always best to consult with a mortgage professional for personalized advice.
The Bottom Line
The Canadian mortgage stress test remains a pivotal factor in the housing market for 2024 and beyond. While recent changes like the removal of the minimum qualifying rate and the upcoming exemption for high-ratio borrowers at renewal may offer some flexibility, the core principle of ensuring borrower resilience in the face of rising interest rates remains firmly in place. As the debate around the stress test’s impact on affordability and accessibility continues, prospective homebuyers and sellers must stay informed and adapt their strategies accordingly. Leveraging tools like the Pegasus Mortgage Lending Affordability Calculator can provide valuable insights into potential borrowing power and budgeting for a mortgage. Whether you’re a first-time buyer navigating the stress test hurdles or a seasoned seller adjusting to a market influenced by tighter lending conditions, understanding the intricacies of the stress test and seeking expert guidance will be key to making sound financial decisions in the Canadian housing market of 2024.
