Canada’s bank regulator keeps mortgage stress test unchanged despite spiking home prices, rising household debt

[Globe and Mail – December 17, 2021]

Canada’s bank regulator said it is not changing the mortgage stress test, calling the borrowing rules “adequate,” even as home prices continue to accelerate and household debt rapidly increases.

The Office of the Superintendent of Financial Institutions, or OSFI, said the mortgage stress test for uninsured mortgages will continue to require borrowers to qualify at a rate of 5.25 per cent. The Finance Department also said the rate would remain the same for borrowers who make a down payment of less than 20 per cent of the property’s purchase price and require mortgage insurance.

The no-change announcement was welcomed by the real estate industry which said things will stay the same for most borrowers.

“If they qualified last week, they qualify this week,” said Leah Zlatkin, mortgage broker with Brite Mortgage Inc., who works in the Toronto region. “This is great news for people who are waiting to buy.”

Borrowers need to prove they can make their mortgage payments at either two percentage points above their actual contract rate, or at OSFI’s rate of 5.25 per cent – whichever is higher.

The five-year fixed-rate mortgage – the most popular type in Canada – is around 2.69 per cent, but the stress test requires borrowers to be able to demonstrate they can afford to pay the interest rate of 5.25 per cent if they borrow from a bank.

Although the Bank of Canada has said the quality of borrowing has deteriorated over the course of the pandemic, OSFI said its rules are protecting banks and the health of the country’s financial system.

“While housing-related vulnerabilities remain elevated, residential mortgage credit risk has only risen modestly,” Ben Gully, OSFI’s assistant superintendent of regulation, said on a conference call with reporters.

OSFI repeated that the 5.25 per cent qualifying rate creates a margin of safety to ensure that borrowers are able to make their mortgage payments if interest rates rise or they lose income.

“OSFI is of the view that that the current minimum qualifying rate remains adequate in the current economic environment,” said Vlasios Melessanakis, a senior OSFI official.

Douglas Porter, chief economist with Bank of Montreal, called the current mortgage stress test “reasonably restrictive.” He said “further tweaks may not have moved the needle much in any event,” given that borrowing continued to soar after OSFI had increased the rate from 4.79 per cent earlier this year.

At the time, national home prices were rising at their fastest pace on record, with smaller cities seeing average real estate values soar by 30 per cent to 40 per cent on a year-over-year basis.

As the economy reopened over the summer, home resales dipped and price appreciation slowed. But activity rebounded in the fall and now market conditions are similar to the spring.

The average home price is now 40 per cent higher than prior to the pandemic, according to Canadian Real Estate Association data. The association said there is less than two months of resale inventory remaining if the pace of sales is the same as November.

The shortage of properties for resale has increased competition, leading borrowers to shoulder greater amounts of debt to buy a property.

Canadian buyers have ignored warnings that interest rates will soon rise, as well as warnings that the country’s housing market is overheated and overvalued.

The Bank of Canada has flagged household debt as an area of concern and has said highly leveraged households are borrowing at a faster pace. OSFI acknowledged that there are more borrowers with a high loan-to-income ratio, but said “that has been supported by extremely low interest rates” at the same time, meaning that the low borrowing costs make it easier for those borrowers to make their monthly debt payments.

Friday’s announcement was a planned communication from OSFI. The regulator had vowed to disclose mortgage stress-test requirements every December ahead of the historically busy spring selling season.

Asked what would trigger a change in the minimum qualifying rate, OSFI said it could not speculate but noted it looks at a range of metrics, including household indebtedness, house price imbalances, macroeconomic data and current mortgage rates.

“It is hard at this point to pinpoint what it would take, but certainly we will be monitoring a variety of factors very closely,” Mr. Melessanakis said.


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