The Stress Test’s Biggest “Stress” Could Start in 2023 or 2024

Canada’s new mortgage stress test begins Tuesday, but its impact may be limited near-term. It’ll cut borrowers’ theoretical buying power by just 4% or so. That won’t exactly remove wide swaths of buyers from the housing market.

The real stress it’ll create for homebuyers might not manifest itself for some years down the road.

On BNN Friday, RATESDOTCA’s Mortgage Editor Rob McLister explained to anchor Greg Bonnell that market expectations for as much as eight rate hikes in the next five years are “absolutely within the realm of possibility” based on past rate hike cycles and the degree of current inflation expectations.

Meanwhile, the banking regulator (OSFI) says its intention is to ensure the new minimum stress test rate “prepares borrowers” for higher rates. So, if OSFI bakes in even 100 basis points of a 200-basis-point hiking cycle to the stress-test rate, that would trim people’s buying power by 12-13% versus today.

Market Hazard

Government policy tightening almost always hurts market sentiment. But, fortunately, Canadian borrowers are good at adapting to macroprudential changes. They tend to tap mom and dad for a bigger down payment, use non-federally regulated lenders with easier stress tests, get co-signors, buy farther from the city or buy smaller homes.

But, a 6.25% minimum stress test rate would not just be a sentiment risk; it would be a demand risk, for at least one to three years.

And remember, OSFI proposes to adjust the stress test floor as little as once a year. That means it might not cut its stress-test floor rate fast enough to cushion a fall in home prices — a fall that could conceivably be exacerbated by its own policy.

Market-based stress tests, like OSFI’s prior stress test proposal, tend to be much better economic shock absorbers — for this very reason.