We may be mortgaged to the hilt, but Canada’s loan default rate is still tiny: Just 0.3 per cent. We’ll do anything to ensure we don’t miss those payments.
We juggle credit cards and car loans and postpone paying our home equity lines of credit, but that doesn’t help with our overall debt level, which hit a record high at the end of last year — we now collectively owe 178 per cent of our disposable income.
That makes many households vulnerable to disaster if someone loses a job or interest rates climb. It also puts Canada’s future prosperity at risk.
That’s why Canada’s bank regulator introduced a stress test 18 months ago that makes it harder for cash-strapped home buyers to qualify for a mortgage — and why, in an unusually blunt letter to the Standing Committee on Finance last month, Canada Mortgage and Housing Corp. CEO Evan Siddall vigorously defended its role in protecting us against dangerous debt levels related to our homes.
But that mortgage lending test has also been blamed for a slump in the Toronto region housing market, with builders, lenders and realtors accusing it of needlessly shutting out first-time buyers and handcuffing move-up consumers to their current bank. The trickle-down effect, they suggest, is stunting the housing supply at a time when Ontario, at least, is desperately short.
It’s an important question: Is the stress test smart government policy that’s helping to bring a frothy housing market under control — perhaps even preventing a devastating housing crash? Or is it too heavy-handed, dampening the economy and making it even harder for regular Canadians to buy a home?
Housing will almost certainly be a central issue in the October federal election and the Toronto Real Estate Board (TREB) will be watching where the parties stand on lending policy, mortgage products and amortization, said the board’s chief market analyst Jason Mercer.
He is among those who wonder if the stress test might be too rigid.
“If you’re at the top of the economic cycle and you don’t feel that you’re going to see too much more in the way of interest rate increases, is it prudent to continue to have a static 2 percentage point spread that you’re stress testing someone against?” said Mercer.
Suggestions from the broader industry for making the test more flexible include tying it to interest rates, confining it only to first-time buyers or applying it to consumers who carry inordinate debt loads.
Siddall’s letter relegates some of the stress test criticism to the “plain self-interest” of groups such as the Canadian Home Builders Association, Mortgage Professionals Canada and the Ontario Real Estate Association, which have all argued for changes.
He is right, said John Andrew of Queen’s University.
“The stress test is a scapegoat for a lot of people in the industry,” said the real estate professor.
Alarmed by rising house prices, particularly in cities, and a mounting dread that consumers weren’t fully appreciating the risk of potential interest hikes, Andrew was calling for more rigorous lending criteria before bank regulator, the Office of the Superintendent of Financial Institutions (OSFI), stepped in.
Its amendment to its B-20 Guidelines was designed to strengthen the underwriting standards of the financial institutions it governs, including Canada’s big banks. It means consumers — even those with a down payment of 20 per cent or more — have to qualify for a mortgage at a rate 2 per cent higher than they will actually pay the bank or 2 percentage points higher than the Bank of Canada’s five-year rate.
Andrew thinks the 2 per cent borrowing cushion is reasonable and he’s not buying the argument that the stress test is solving a default problem that Canada doesn’t have.
“(Mortgage) default rates are incredibly low because we’ve always had a culture of very responsible lending. I would argue the stress test was the next necessary step to ensure that continues,” he said.
The real estate industry doesn’t like the stress test, he said, because it depends on the commissions of buyers who want to move to larger houses — but now many are avoiding the stress test by borrowing against their homes to renovate rather than move. Mortgage renewals aren’t stress tested unless the borrower switches to another regulated lender.
The B-20 amendment is not the only factor in dampening demand for new construction housing where sales hit a 20-year low last year. But it is a contributor, said Cheryl Shindruk, chair of the Building and Land Development Association (BILD), which represents Toronto-area homebuilders. And that has an indirect impact on supply.
“Builders will only build what they can sell. If the demand is not there, then the building slows down,” she said.
“That doesn’t mean the demand has gone away. The demand is there but it isn’t being expressed in the marketplace,” said Shindruk, who notes the Canadian Home Builders Association is reporting a 33 per cent decline in first-time homebuyer activity.
At Geranium Homes, where she is an executive vice-president, Shindruk says stress testing has shut out previously qualified buyers — consumers who had already owned a home and had secure employment.
“While we understand that first-time home buyers, and particularly millennials and new Canadians, seem to be the most impacted by it, it’s definitely affecting buyers across the centre,” she said.
BILD isn’t pushing for the elimination of the stress test, but it would like the test to be more dynamic by tying it to interest rates or applying it only in cases of excessive debt levels, said Shindruk.
“The other thing that would be helpful would be to allow a 30-year amortization period,” she said.
Toronto realtor John Pasalis dismisses the idea that declines in single-family home construction are related solely to lending qualifications. There were other factors, including too much speculation in some parts of the Toronto region, particularly in the 905-area communities around the city.
“Lowrise new construction sales tanked in 2017 and 2018 because the housing market in the 905 tanked. Prices fell 25 or 30 per cent but builders didn’t want to lower their prices that much — or couldn’t — because they pre-sold a lot,” he said.
Pasalis says builders are behaving like stubborn sellers, who simply don’t want to reduce their prices. They will wait until demand pushes prices higher to increase their profits.
But he also disagrees with Siddall’s public assertion of self-interest among industry associations. The arguments in favour of protecting against excessive debt should stand on their own merits, said Pasalis. After all, everyone has an interest.
Pre-stress test, CMHC was insuring a lot of consumers who were buying investment properties, he said.
“They were insuring people with $1.5 million homes who were refinancing their mortgages to take out more debt. They only stopped doing that in October 2016. That’s what fuelled the bubble,” said Pasalis.
He argues that after more than a year, consumers have adjusted to the stress test. Removing it now would only add heat to an already competitive market.
Besides, Toronto region resale home prices have risen moderately every month so far this year. Sales rose in the double digits in both April and May, according to TREB, although it qualifies those year-over-year numbers as coming off a 15-year low in 2018. Still, there’s no doubt that buyers are stepping back into the market, said Mercer.
Nevertheless, the role of the stress test can’t be underestimated when it comes to the pace of recovery from the real estate bubble that popped almost immediately after the former Ontario Liberal government launched its Fair Housing Plan in April 2017.
“It’s tough to argue the stress test hasn’t been one of the largest, if not the largest factors affecting demand in the GTA,” said Mercer.
Tess Kalinowski is a Toronto-based reporter covering real estate. Follow her on Twitter: @tesskalinowski