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Mortgage stress test rules get more lenient for first time

There's good news for anyone who has decried the new mortgage stress test rules, as the hurdle set up by Ottawa to save borrowers from themselves just got a bit lower.

Posted mortgage rates in Canada have inched lower, so stress test benchmark has followed suit

Canadian mortgage rates have quietly fallen this year, and so has the stress-test rate that lenders must qualify borrowers against. (Daniel Munoz/Reuters)

For the first time since the government implemented new stress test rules on Canadian home loans, the bar has been lowered — meaning a would-be homebuyer could be approved for a bigger mortgage today than they would have yesterday.

The so-called stress test, formally in place since January 2018, is a financial bar that any Canadian looking to take out a mortgage must pass to be approved for one. Regardless of what deals they may have been offered by a lender in the real world, for regulators to sign off on the loan, the borrower's finances must be tested as though their mortgage rate is at a higher level. The idea is to save borrowers from biting off more debt than they can chew and ensure they have some financial wiggle room if rates rise.

The stress-test level is set at either two percentage points above the actual mortgage rate or whatever the average five-year posted rate is at Canada's big banks, as calculated by the Bank of Canada — whichever is higher.

That bank rate hasn't changed since May 2018, when it rose to 5.34 per cent. But this week, it inched down to 5.19 per cent, the first time it has decreased in almost three years.

More purchasing power

The impact of the slight lowering of that bar is to let people qualify for a bigger mortgage than they could before, even if everything else in their finances has stayed the same. It has the effect of giving them slightly more purchasing power, allowing them to fish in a slightly more expensive pond full of homes.

It's not a huge move, by any stretch.

Rate comparison website Ratehub.ca calculates the typical borrower can now afford about 1.4 per cent more home than they could previously. Assuming a borrower had a down payment of at least 20 per cent, no other debts to speak of, and earned $100,000 a year, under the previous test level, they would have qualified for a home valued at $589,000. Today that same family can buy a house worth $597,000.

It doesn't make their mortgage any easier to pay off. It just allows them to theoretically buy a slightly more expensive home than they would have previously been allowed to.

Samantha Brookes, CEO of broker Mortgages of Canada, says overall, the stress test has put a chill on the market, but she doubts that this week's move will make a major dent in its impact.

"It allows someone purchasing to buy a little bit more but it's not that significant," she said. "Consumers are in this wait-and-see pattern — it's still difficult to get into the market because that stress test is there."

And the tiny amount of extra wiggle room that this week's move may make the dollars and cents add up a little better on paper, but the real impact may be all in our heads, says Nick Kyprianou, president of RiverRock Mortgage Investment Corporation, a Toronto-based alternative mortgage lender.

Kyprianou is somewhat of a rarity in that he makes his money in real estate, but isn't among those who blame the implementation of the stress test in 2018 for taking away the punch bowl and ending a real estate party in full swing. 

He may have a bias in that the stress test made his business busier, as people shut out of traditional lenders by the new rules flocked to alternative lenders. "But it was a reasonable thing to do," he says. "As a homeowner and a citizen it wasn't the wrong decision — things were irrational."

Kyprianou says the stress testing level moving almost imperceptibly lower is likely to help the market just by instilling confidence, because it's not just the theoretical testing level that's lower — actual mortgage rates are falling too.

Fixed mortgage rates are priced on what's happening in the bond market, which has been signalling for months that it expects cheaper lending rates to come.

The U.S. central bank could cut its benchmark interest rate as soon as the end of this month, and while Canada is expected to stand pat for a while, the Bank of Canada is not immune to the global forces that may push rates down even lower.

As long as house prices don't crater, rates in the real world moving lower will have a much bigger impact than this week's tiny wobble in the stress test, Kyprianou says.

"This is a psychological game. If people feel confident they'll get back in the market."