Why does Canada have a stress test?
The mortgage stress test, also known as the B-20 Guideline, has been frustrating homebuyers since it was first implemented by the Office of the Superintendent of Financial Institutions, or OSFI, in January 2018. But it's supposed to help buyers.
When they stretch themselves financially to afford homes, it leaves little room in their budgets for higher mortgage costs. If mortgage rates were to increase significantly over the course of a homeowner's mortgage term, it could potentially make it much more difficult, if not impossible, for that borrower to make payments.
So, by baking a theoretical increase into the mortgage rates buyers are offered, OSFI's intent is to ensure that anyone buying a home will be able to absorb the cost of a mortgage that becomes more expensive.
And those higher mortgage costs are coming. During a recent news conference, Bank of Canada Governor Tiff Macklem warned homebuyers that the rates they’re seeing today are "unusually low," and that buyers should not expect home values to keep rising rapidly.
"Borrowers and lenders both have roles in ensuring that households can still afford to service their debt at higher rates," Macklem said.
The terms of the original stress test said borrowers had to prove they could manage a mortgage at a rate that was either 2% higher than the rate offered by their lender or equal to the five-year benchmark rate published by the Bank of Canada — whichever was higher.
The BoC’s five-year benchmark at the time was 4.79%, so if your lender offered you just a 2% interest rate on your mortgage, you had to prove you would be able to afford the same mortgage at 4.79%.
Come June 1, that hurdle gets a little higher.
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Not the end of the road for homebuyers
A stress test of 5.25% is not likely to shut would-be buyers out of the housing market, says BMO chief economist Doug Porter.
"To be clear, this doesn’t increase their actual costs," Porter says. “It just throws up some potential limits on what they can borrow — if they were already borrowing up to the limit, and if they had a downpayment of 20% or more. Even then, we estimate that if a potential buyer’s maximum mortgage had previously been $1 million, now it will be $955,000."
The tougher stress test will impact all homebuyers. It won’t only eat into your buying power, but that of every other house-hungry Canadian. Porter says the across-the-board nature of the stress-test tweak may help rein in some of Canada’s most out-of-control real estate markets.
"Think about it this way: If Ottawa gave every renter in the country a $10,000 gift card that could only be used to buy a new home, the only winner from that would be home sellers, not the buyers, because every home price in the country would immediately go up $10,000,” he says.
"Think of this as almost the reverse," Porter continues. "They are possibly taking away a bit of buying power, but that hurts sellers mostly."
With Canada’s mortgage market being as diverse as it is, not every lender in the country is actually required to abide by B-20. Private lenders, mortgage investment corporations, alternative lenders and provincially regulated credit unions all provide mortgages free of any stress test requirements.
But you’ll still have to wow them with your income and your creditworthiness. There's no getting around that.
What should you do come June 1?
While it would be nice to think that a stricter stress test will chase enough buyers from the housing market that prices start to recede, don’t count on it.
In April, the average sale price of a home in Canada was $696,000 — up 41.9% higher from a year before, according to the Canadian Real Estate Association. That kind of price growth can’t be reversed overnight.
If you aren’t able to get a mortgage preapproval in place before June 1 ushers in the higher stress test, Kolinski says your homebuying plans may hinge on your ability to cut costs and drive income.
You want to anything you can do to save up a heartier down payment, says broker Chris Kolinski with iSask Mortgages in Saskatchewan.
“If you were preapproved to buy a home for $500,000 with a 20% down payment before the stress test changes, you might only be qualified to buy a $480,000 home after they’re implemented," Kolinski says. “This means you would need to save up an additional $20,000 to make up the difference."
There’s no shortage of ways to save a little extra cash, like using an app that pays actual cash back on your everyday purchases.
First-time buyers might also consider turning to another trusted financial institution to make up for any potential shortfall that results from the stress test.
"You have to go to the bank of Mom and Dad," says Danny Ibrahim, CEO of KeyRate Mortgage. "That’s typically what’s happening in the marketplace, and I believe it will continue to happen for the next couple of years."
Don’t let the higher stress test get you down
In terms of preventing people from approaching the market, an increased stress test won’t do nearly as much damage as high home prices already have.
And today’s low mortgage rates should help compensate for some of your reduced buying power.
“Rates are so completely, compellingly low," Ibrahim says. "Everybody’s jumping on the lower rates."
So don’t let all the hype swirling around the stress test knock you off course. Get out there and do what any successful homebuyer does.
The best mortgage rates go to the borrowers with the highest scores, so check your credit score for free. If it needs improvement, it’s better to know now rather than finding out after you’ve stumbled upon your dream home.
Reach out to a mortgage broker with any questions you have around financing and affordability. Find a mortgage broker you feel comfortable opening up to, because the more questions you answer honestly, the better the odds a broker will find you a mortgage solution that fits your budget, your lifestyle and your long-term financial plans.
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