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According to Loans Canada, the current mortgage stress test is “a way of testing how you and your finances might be affected by a sudden bout of financial turmoil, such as loss of employment.” It also carries the added benefit of discouraging new home owners from getting mortgages too big to handle. Under the current laws, a hopeful home buyers needs to be able to prove he or she can make mortgage payments if interest rates were 2 percentage points higher than they currently are.
Originally this test was meant to be applied only to buyers who weren’t able to drop a 20% down payment on their mortgage, and thus required mortgage insurance. But the Office of Superintendent of Financial Institutions (OSFI) decided on October 17th, 2017 to apply that stress test to everyone, even borrowers simply looking to change lenders when their mortgage term ended.
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Given the historic level of personal debt growth for the average Canadian, rumours of an upcoming market correction, and the Bank of Canada steadily rising its overnight interest rates, it makes perfect sense why the government would introduce a mortgage stress test. It’s not hard to imagine that interest rates will be at least 2 percentage points higher in five years from now.
Of course, there is nothing wrong about having a mortgage stress test. Ensuring that mortgage holders have the ability to repay their debts is essential. But a stress test should also be balanced. After more than a year of its implementation, and the with power of hindsight on our hands, some economists are claiming that the stress test needs to be adjusted.
In Mortgage Professionals Canada’s (MPC) latest semi-annual report on the state of Canada’s residential market, Will Dunning makes the claim that the stress test is much more restrictive than it should be, denies young middle-class Canadians “the opportunity to build their financial futures through home ownership”.
The stress test tests mortgage holders’ ability to pay a higher monthly mortgage now, but fails to account for wage increases, and basic financial math. The average Canadian wage has consistently increased by around 2% per year for decades. As a result, a borrower’s ability to carry a higher interest rate mortgage come mortgage term renewal time would be higher. Not only that, but as mortgage holders pay more and more money towards their principal, future term renewals will calculate a higher interest rate, but on a smaller principal amount.
Dunning believes a better stress test would account for those factors, and be closer to 0.75 percentage points instead of 2