New Stress Test, Might Stress You Out
The February 18th,2020 announcement by the Department of Finance stated that as of April 6th, 2020 there will be a new way to determine the minimum qualifying rate for insured mortgages, commonly known as the “stress test rate”. The new stress test will be based on the “weekly median 5 –year fixed insured mortgage rate from mortgage insurance applications, plus 2%.” The same methodology is being considered by the Office of the Superintendent of Financial Institutions (OSFI) for uninsured mortgages.
Many have been quick to tout this as a “win” for homebuyers and positive for the real estate market, but is it really? Let’s dissect the changes to see the full impact.
First let’s start with the fact it’s based on the median rate. The median is the middle number, so based on the rates of the lenders, the lender in the middle spot would be setting the basis for the benchmark rate. For example, let’s say the following are the rates offered by 5 lenders:
Lender 1: 3.04%
Lender 2: 2.84%
Lender 3: 2.89%
Lender 4: 3.09%
Lender 5: 3.09%
When listed out median rate is 3.04% -> 2.84%,2.89%,3.04%,3.09%,3.09%
As such the stress test rate would be 5.04% versus the current 5.19% would mean that a buyer(s) with a household income of $95,000 purchasing a property with property taxes of $3,200 per year would qualify for a mortgage of $411,754.05 versus $405,788.35 under the old stress test. Although higher, this $5,965.70 most likely won’t allow the buyer to move into the next size home or make much impact on their purchase or the market on a whole.
So far this isn’t looking positive for the new changes to be beneficial, but let’s look at the impact of the rest of change, specifically the fact that it’s based on the weekly rates. Consider a scenario where a home buyer(s) seeks a pre-approval. Based on the median rate stress test they are pre-approved for a $565,000 mortgage. Fantastic, they are all excited and head out with their realtor to look at homes. After some searching they put in an offer, then there’s a little bit of back and forth negotiation but they end up with an accepted offer at the price they can afford. Based on their purchase price and down payment, they will need a mortgage for $562,000 and they were pre-approved for $565,000 so they’re looking good, right? Unfortunately during the time of their pre-approval and their offer being accepted, the weekly median rate had changed and now they only qualify for a mortgage of $558,000. They don’t have any additional money to put down and are faced with having to cancel their offer. So how farfetched is this scenario? It’s in fact very realistic, a stress test that can be this responsive to market changes has the potential to leave a lot of buyer in this very situation and cause significant disruption to real estate market with properties being conditionally solid just to go back on the market when the deal falls through.
So far this isn’t looking positive for the new changes to be beneficial, but let’s look at the impact of the rest of change, specifically the fact that it’s based on the weekly rates. Consider a scenario where a home buyer(s) seeks a pre-approval. Based on the median rate stress test they are pre-approved for a $565,000 mortgage. Fantastic, they are all excited and head out with their realtor to look at homes. After some searching they put in an offer, then there’s a little bit of back and forth negotiation but they end up with an accepted offer at the price they can afford. Based on their purchase price and down payment, they will need a mortgage for $562,000 and they were pre-approved for $565,000 so they’re looking good, right? Unfortunately during the time of their pre-approval and their offer being accepted, the weekly median rate had changed and now they only qualify for a mortgage of $558,000. They don’t have any additional money to put down and are faced with having to cancel their offer. So how farfetched is this scenario? It’s in fact very realistic, a stress test that can be this responsive to market changes has the potential to leave a lot of buyer in this very situation and cause significant disruption to real estate market with properties being conditionally solid just to go back on the market when the deal falls through.
I would be remiss to not note that in addition to the above points, even if the new stress test did have a significant impact to a buyer’s purchasing power, we are already in a low supply market and any change to additionally purchasing power would be diminished because it would move the market price upward relative to the increase purchasing power. The end result, although the buyer can purchase for more, they will also have to pay a higher price as well, thus negating the intended effect.
There will still be some that argue that some change is still positive, to which I don’t disagree, however the fact as outlined above still support that this change is still vastly smoke and mirrors and looks more like political maneuvering rather than doing what’s in the best interest of the public.
To read the full article by the Department of Finance you can go to this link:
About the Author: Sadiq Boodoo is the Principal Broker of Approved Financial Services. Sadiq has over 21 years banking and financing experience and studied Management and Economics at the University of Toronto.