The much-maligned mortgage stress test is changing.
The Department of Finance has confirmed that as of April 6, 2020, homebuyers getting insured mortgages will have an easier time qualifying.
Instead of having to prove they can afford a mortgage payment at today’s benchmark rate of 5.19%, they’ll be qualified on the weekly median 5-year fixed insured mortgage rate plus 2%.
As of today, that rate would be around 4.89%, or 30 basis points lower than the current minimum stress test rate of 5.19%.
Why Did the Stress Test Rate Change?
Critics of the current stress test rate—and there were many—argued that as mortgage rates fell since early 2019, the stress test rate was kept unnecessarily high. That resulted in many otherwise qualified borrowers not being approved for an insured mortgage.
Up till now, the stress test rate has been based on the Big 6 banks' posted 5-year fixed rate. Banks have lowered that rate just 15 bps since Jan. 1, 2019, despite a 73-bps drop in the lowest 5-year fixed rates over that span.
The big banks have their own reason for keeping 5-year posted rates artificially high, and it’s spelled P.R.O.F.I.T. Among other things, high posted rates help banks exact higher mortgage prepayment penalties.
Is the New Stress Test More Flexible?
Yes. In December, Prime Minister Justin Trudeau directed Finance Minister Bill Morneau to review recommendations from financial institutions to find a way to make the stress test more “dynamic.”
The new formula for the stress test achieves that. The reason: the new benchmark rate will be calculated on a weekly basis, ensuring it remains in-tune with actual market rates.
Will it Be Easier to Pass the Stress Test?
The short answer is yes.
Today, actual default-insured mortgage rates are as low as 2.36% while the qualifying rate is 5.19%. That means mortgage applicants currently have to qualify for a rate that’s up to 283 basis points higher.
If rates remain where they are today, that gap will narrow by about 30 basis points on April 6. That would decrease the income required to buy a $300,000 home by roughly $1,500. (Assuming a 25-year amortization and 5% down payment).
Will the Stress Test Rate Change Cause Home Prices to Rise?
Most likely. Analysts estimate the new benchmark rate will result in roughly 3% more buying power for a typical borrower.
Given the already competitive start to this year’s spring homebuying season—and limited supply—increased buying power will fuel competition among buyers. That should lead more purchasers to come in with higher bids.
What About the Stress Test for Uninsured Mortgages?
Stress test changes are also on the way for uninsured mortgages, that is, borrowers with 20%+ equity.
The Office of the Superintendent of Financial Institutions (OSFI) controls that test and says it’s considering the same new benchmark qualifying rate. Albeit, it will also require borrowers to prove they can afford a rate that is 200 bps higher than their actual (“contract”) rate.
OSFI will accept public input on its proposal until March 17, 2020, and presumably make an official announcement soon thereafter.