Stress Test Changes to Increase Buying Power

The busy spring home-buying season may be more frenzied as changes to the country’s mortgage stress test come into effect.

Beginning April 6, Canadians applying for default-insured mortgages — those with less than 20% down payment on a new purchase — will have an easier time qualifying for a loan and perhaps even a bigger amount. While this is particularly good news for first-time homebuyers, some of which have been shutout of the market since the stress test was introduced in January 2018, it could add fuel to Toronto’s already hot housing market.

Under the new rules, the minimum qualifying rate for borrowers will be 2% above the rate their lender is offering or 2% above the weekly median five-year fixed insured mortgage rate. (A similar change is likely to come for uninsured mortgages, according to the Office of the Superintendent of Financial Institutions, which is consulting on the matter until mid-March.)

This means the stress test will be based on the actual mortgage costs rather than the advertised rates.

Currently, the threshold, or minimum rate, to qualify for a mortgage is based on the Bank of Canada’s five-year benchmark posted mortgage rate.

If the new stress test rules took effect the day of the federal announcement, the rate would be 4.89%, or 30 basis points (0.3%) less than the current stress test rate of 5.19%, according to the Department of Finance. In real terms, this could translate into big savings for borrowers, increasing their purchasing power by about $15,000 on an approximately $500,000 home, assuming a 5% down payment and 25-year amortization.

With the Bank of Canada’s recent decision to cut interest rates amid coronavirus concerns, and several banks and financial institutions following suit, the new stress test rate for a high ratio mortgage could potentially be 4.39%, as the lowest going rate is 2.39%.

The stress test was implemented in January 2018, to ensure borrowers would be able to pay down their debts if interest rates rose substantially above their actual mortgage rate. If the borrower fails the test, a lender isn’t allowed to loan them money.

The original test had been criticized as favouring the big banks, as the rates offered by other lenders for insured mortgages are typically much lower.