Ottawa unveils new mortgage stress-test rules that will make it easier to qualif

Ottawa is revamping the mortgage stress test to make it easier for borrowers to qualify for loans in a move that could add fuel to already hot housing markets.

Finance Minister Bill Morneau announced Tuesday that a key benchmark rate set by the Bank of Canada will be replaced by a new rate when calculating stress tests for insured mortgages, which have a down payment of less than 20 per cent of the purchase price.

Canada’s banking regulator, the Office of the Superintendent of Financial Institutions, looks poised to follow suit with a proposal to apply the same new benchmark rate to stress tests on uninsured mortgages, for which borrowers make larger down payments.

The current stress test, which was introduced in 2016 and expanded in 2018, has drawn widespread criticism from mortgage professionals and would-be homebuyers, even as OSFI has staunchly defended it. As it stands, lenders are required to test whether borrowers could make their mortgage payments at an interest rate that is either two percentage points higher than their actual contract, or at the Bank of Canada’s benchmark five-year mortgage rate – whichever is higher.

The new benchmark rate will be set by looking at the rates offered to customers applying for insurance on five-year fixed-rate mortgages. It will then take the median of those rates, and add two percentage points as a buffer against shocks such as rising interest rates or a borrower losing their job.

Mr. Morneau said the aim is to make the stress test, which has drawn criticism for being onerous and inflexible, “more dynamic to market conditions,” while still keeping it intact.

“We think these are positive moves to ensure that the approach remains effective for Canadians and that it also deals with changing market conditions,” Mr. Morneau told reporters on Tuesday.

The proposed rule changes would make it easier for some borrowers to get bigger loans. That could ignite further activity in the Toronto region’s real estate market, which has already taken off this year as buyers compete with aggressive offers.

Economists including Bank of Montreal’s Douglas Porter has warned against stimulative measures such as relaxing the stress test. The proposed benchmark for uninsured mortgages could “put further upward pressure on prices, especially in markets that are already leaning to a seller's market,” Mr. Porter said Tuesday.

Federal officials had become concerned that the Bank of Canada rate, which stands at 5.19 per cent, was no longer tracking the market as well as it had. At that level, it sets the floor for the stress test at roughly 2.3 percentage points higher than the average five-year mortgage rate borrowers are actually paying.

By contrast, the new median-based benchmark is currently lower at 4.89 per cent as of Tuesday, according to OSFI, although it could change weekly. And mortgages will still be stress-tested at a minimum of two percentage points above the client’s contract rate, according to OSFI.

Switching to the new benchmark rate would boost buying power by almost 3 per cent, depending on the borrower, according to Robert McLister, mortgage broker and founder of rate comparison website Ratespy.com. “That’s enough to trigger a meaningful demand increase this spring, particularly given the bullish psychological impact it’ll have,” Mr. McLister said.

Ron Butler, a mortgage broker with Butler Mortgage Inc., estimated that the current difference between the two benchmark rates would allow a customer qualified for a $500,000 mortgage with a 5-per-cent down payment to spend $528,125.

Mr. Morneau consulted with federal agencies, including OSFI and the Bank of Canada, after Prime Minister Justin Trudeau asked him to gather recommendations to make the stress test “more dynamic."

OSFI is seeking feedback on the proposed changes until March 17, and plans to finalize the new rule by April 1.

In late January, OSFI assistant superintendent Ben Gully said in a speech that the central bank’s benchmark “is not playing the role that we intended” in calculating the stress test, and has become "less responsive to market changes.” That benchmark is derived from posted mortgage rates at Canada’s largest banks, which are typically much higher than the rates most borrowers actually pay.

That gap has widened as falling bond yields have driven down the cost of a mortgage, but posted mortgage rates – which are used to calculate penalties for borrowers who break their mortgages early – have stayed stubbornly high. Toronto-Dominion Bank slashed its posted five-year mortgage rate to 4.99 per cent from 5.34 per cent in early February, but other banks continue to offer posted rates of 5.19 per cent or more.

By adopting a new benchmark, OSFI aims "to address the limitations of the current benchmark rate while preserving the integrity of the overall qualifying rate,” Mr. Gully said in a statement.

Yet some mortgage brokers played down the impact of the new benchmark and said the proposal gives no relief to borrowers who want to switch lenders at renewal time. "If the intent is to help buyers, they have failed,” said Elan Weintraub, a mortgage broker with Mortgageoutlet.ca.

Paul Taylor, president of Mortgage Professionals Canada, an industry association for mortgage brokers, said even with the new benchmark the stress test will still be too onerous. While it is “very good” that Ottawa is swapping the Bank of Canada’s benchmark mortgage rate for a new standard, he said, his group thinks the test should be set at 0.75 percentage points above the actual mortgage rate, rather than two percentage points.