Should Canada’s banking regulators abandon the mortgage stress test?

In 2016, the Canadian government introduced the mortgage stress test as a vital tool to curb risks associated with mortgage lending, especially when the Canadian real estate market experiences higher prices and lower interest rates. It was also amended in 2021 to require borrowers to prove they can maintain mortgage repayments that are 200 basis points above the contracted rate.

The mortgage stress test maintains two thresholds: a minimum qualifying rate (MQR) and an interest rate that is two percentage points higher than the borrower’s mortgage rate. As a result, today’s homebuyers could be experiencing rates between seven and nine percent.

A chorus of housing and finance arguments argue that it is time to ditch or relax this measure as interest rates have risen to their highest levels since before the global financial crisis. Indeed, when the policy was introduced nearly a decade ago, mortgage rates were nearly half of today’s rates. Since July, the conventional five-year fixed-rate mortgage lending rate has been around six percent.

Therefore, critics contend the Bank of Canada’s (BoC) tightening efforts have achieved some safeguards regulators have aimed to install throughout the nation’s housing sector, making the tool obsolete.

“I am all for building a buffer for people’s financial situation, but the stress test limits the amount people can borrow,” Matt Albinati, a mortgage broker with TMG The Mortgage Group, told Canadian Mortgage Trends. “You look back a year, the stress test was doing a pretty good job. This time—or near in the future—it might be a good time to take a closer look at it.”

But officials have been firm on the matter: no relief on the stress test is coming to the mortgage market.

No Relief on Stress Test Coming

The Office of the Superintendent of Financial Institutions (OSFI) says it will not be changing the mortgage stress or exempting some parties from the protective measure.

In response to the Canadian real estate industry’s wider fears about the possibility of new lending rules, the country’s chief bank regulator effectively shot down any expectation that the stress test is going away. In fact, industry experts make the case that the OSFI ostensibly doubled down on the method.

“When a borrower opts to switch lenders, a new loan is created. We therefore expect that the loan be fully underwritten, including application of the MQR for uninsured mortgages to assess debt affordability,” the OSFI said in an Oct. 16 report. “This is because the new lender must do its own due diligence as it will own the credit risk for an uninsured loan.”

In addition, the OSFI surprised mortgage brokers and lenders with this statement:

“Insured borrowers, however, are exempt from the re-application of the MQR when switching lenders at renewal. This is because the borrower’s credit risk has been transferred for the life of the loan to the mortgage insurer.”

For the most part, the mortgage sector had believed insured borrowers faced stress tests upon renewal if they transitioned to a new lender.

Meanwhile, Canada’s top banking regulator noted that exempting all mortgage renewals from the stress test “could cause lenders to compete for loans that do not meet” its expectations. At the same time, the OSFI conceded that it would assess data of uncompetitive rates for borrowers who cannot switch lenders and would “take action if warranted.”

And instead of dismantling the mortgage stress test, the OSFI is considering adding layers to the protective measure.

Regulators could mandate lenders to add more components to the stress test or insert a qualifying amortization period. This could be achieved by connecting the stress test to debt service metrics to determine the borrowers’ abilities to pay their loans and other expenses.

“We believe there is merit in lenders applying an explicit, qualifying amortization limit, and we will continue to evaluate this proposal,” the OSFI said.

Stress Test ‘Not Perfect’

At the September Scotiabank Financials Summit, OSFI Superintendent Peter Routledge conceded that the mortgage stress test “was not perfect.”

“Perhaps it is better to call it incomplete,” he said at the event. “We seek an integrated set of common-sense protections that work effectively both when interest rates are higher than normal, like today, and when interest rates are lower than normal, like during the COVID years.”

Industry leaders are holding out hope that maybe Routledge will heed the sector’s calls and make the necessary adjustments. Others think that the OSFI will only intensify the stress test, adding to borrowers’ growing costs.

Courtesy RE/MAX Canada

The Bank of Canada today held its target for the overnight rate at 5%, with the Bank Rate at 5¼% and the deposit rate at 5%. The Bank is continuing its policy of quantitative tightening.

The global economy continues to slow and inflation has eased further. In the United States, growth has been stronger than expected, led by robust consumer spending, but is likely to weaken in the months ahead as past policy rate increases work their way through the economy. Growth in the euro area has weakened and, combined with lower energy prices, this has reduced inflationary pressures. Oil prices are about $10-per-barrel lower than was assumed in the October Monetary Policy Report (MPR). Financial conditions have also eased, with long-term interest rates unwinding some of the sharp increases seen earlier in the autumn. The US dollar has weakened against most currencies, including Canada’s.

In Canada, economic growth stalled through the middle quarters of 2023. Real GDP contracted at a rate of 1.1% in the third quarter, following growth of 1.4% in the second quarter. Higher interest rates are clearly restraining spending: consumption growth in the last two quarters was close to zero, and business investment has been volatile but essentially flat over the past year. Exports and inventory adjustment subtracted from GDP growth in the third quarter, while government spending and new home construction provided a boost. The labour market continues to ease: job creation has been slower than labour force growth, job vacancies have declined further, and the unemployment rate has risen modestly. Even so, wages are still rising by 4-5%. Overall, these data and indicators for the fourth quarter suggest the economy is no longer in excess demand.

The slowdown in the economy is reducing inflationary pressures in a broadening range of goods and services prices. Combined with the drop in gasoline prices, this contributed to the easing of CPI inflation to 3.1% in October. However, shelter price inflation has picked up, reflecting faster growth in rent and other housing costs along with the continued contribution from elevated mortgage interest costs. In recent months, the Bank’s preferred measures of core inflation have been around 3½-4%, with the October data coming in towards the lower end of this range.

With further signs that monetary policy is moderating spending and relieving price pressures, Governing Council decided to hold the policy rate at 5% and to continue to normalize the Bank’s balance sheet. Governing Council is still concerned about risks to the outlook for inflation and remains prepared to raise the policy rate further if needed. Governing Council wants to see further and sustained easing in core inflation, and continues to focus on the balance between demand and supply in the economy, inflation expectations, wage growth, and corporate pricing behaviour. The Bank remains resolute in its commitment to restoring price stability for Canadians.

Courtesy the Bank of Canada

NOVEMBER 2023 HOUSING MARKET UPDATE

December 1, 2023

Increased listings, strong sales, and price growth.

New listings in November reached 2,227 units, nearly 40 per cent higher than the exceptionally low levels reported last year at this time. Gains in new listings occurred across most price ranges, but the most significant gains occurred from homes priced over $600,000.

Despite the year-over-year jump in new listings, inventory levels remained low thanks to relatively strong sales. With 1,787 sales in November, the sales to new listings ratio remained high at 80 per cent, and the months of supply remained below two months.

“Like other large cities, new listings have been increasing,” said CREB® Chief Economist Ann-Marie Lurie. “However, in Calgary, the gains have not been enough to change the low inventory situation thanks to strong demand. Our market continues to favour the seller, driving further price growth.”

As of November, the benchmark price was $572,700, up over last month and nearly 11 per cent higher than November 2022. Year-to-date, the average benchmark price has risen by over five per cent.

Detached

Limited supply choice for homes priced below $700,000 has been the primary cause of the decline in detached home sales. While November reported a marginal gain over last year, year-to-date sales have declined by 20 per cent. November saw a rise in new listings compared to the previous year, but higher-priced homes drove most gains. This has left the detached market with exceptionally tight conditions for prices below $700,000 and more balanced conditions for higher-priced homes. Overall, the month of supply remains exceptionally low at under two months.

Persistently tight conditions continue to cause further price gains in the detached market. As of November, the unadjusted benchmark price reached $699,500, a slight increase over last month and over 13 per cent higher than last November. While detached home prices are much higher than last year's levels in every district, year-to-date gains are the highest in the most affordable districts of the North East and East. 

Semi-Detached

November saw a boost in new listings compared to last year, helping to prevent a year-over-year decline in inventory levels. However, inventory levels are still over 40 per cent below typical levels seen in November. With a sales-to-new-listings ratio of 77 per cent and a month-of-supply below two months, conditions remain exceptionally tight, especially for homes priced below $700,000. 

Despite tight conditions, benchmark prices remained stable compared to last month. However, at an unadjusted benchmark price of $628,700, prices are still over 12 per cent higher than last year. The year-to-date average benchmark price has risen by nearly seven per cent, with the largest gains occurring in the North East and East districts.

Row

New listings rose again this month compared to last year. The 370 new listings were met with 267 sales, and for the first time since 2021, the sales-to-new-listings ratio fell below 75 per cent. The jump in new listings was enough to support a gain in inventory levels compared to last month and last year. While inventories are still nearly half the levels we traditionally see, this did help cause the months of supply to push up to 1.6 months, a significant improvement from the less than one month of supply that has persisted over the past seven months. While conditions are much more balanced in the higher price ranges, there is less than one month of supply for homes priced below $500,000.

Despite the shift away from exceptionally tight conditions, prices still rose over the last month and last year. As of November, the unadjusted benchmark price reached $429,100, 21 per cent higher than last November and an average year-to-date gain of nearly 13 per cent.

Apartment Condominium

Thanks to the relative affordability of the apartment-style homes, sales continued to reach record highs in November, contributing to year-to-date sales of 7,487. With one month left in the year, sales have already surpassed last year’s record high. This, in part, was possible thanks to the growth in new listings. While inventory levels are similar to levels reported last year, with less than two months of supply, conditions still favour the seller, placing further upward pressure on prices. 

The unadjusted November benchmark price reached $320,100 in November, a monthly gain of over one per cent and a year-over-year increase of 18 per cent. Year-to-date price gains have occurred across every district in the city, with some of the largest gains arising in the lower-priced North East and East districts.

REGIONAL MARKET FACTS

Airdrie

Gains in November sales were not enough to offset earlier pullbacks, leaving year-to-date sales down by over 26 per cent over last year's record levels. Much of the decline has been driven by the detached market, which has struggled with supply, especially in the lower price ranges. New listings in November did improve over last year's levels. Still, thanks to the gain in sales, the sales-to-new listings ratio rose to 96 per cent, preventing any significant shift from the low inventory levels. 

With less than two months of supply, we continue to see upward pressure on home prices. In November, the unadjusted benchmark price rose over last month, reaching $524,500, a year-over-year gain of 11 per cent. Year-to-date price gains have been the highest in the apartment sector at 17 per cent, with detached and semi-detached prices rising by nearly six per cent.

Cochrane

With 87 new listings and 51 sales, the sales-to-new listings ratio fell to 59 per cent in November, the first time it fell below 60 per cent since 2020. Higher-priced properties have primarily driven the recent gain in new listings. Improved new listings compared to sales did help support increases in inventory levels. However, November inventory levels remain over 30 per cent below long-term trends.

Tight market conditions have supported further price growth in Cochrane. As of November, the unadjusted benchmark price reached $548,600, a monthly gain of over one per cent and a year-over-year increase of 11 per cent. On average, year-to-date benchmark prices have increased across all property types, with the most significant gains occurring in the apartment condominium sector at over seven per cent. 

Okotoks

November saw a boost in new listings, helping support some of the year-over-year gain in sales. The rise in new listings compared to sales also helped support gains in inventory levels. However, inventory levels are nearly half what we would typically see in the market in November. Nonetheless, the shift this month did help push the months of supply up to nearly two months. 

While the months of supply did improve, conditions remained exceptionally tight, and prices continued to trend up this month. As of November, the unadjusted benchmark price was $590,200, a one per cent gain over last month and over eight per cent higher than last November.

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