How does the stress test work?
The stress test, also known as the B-20 Guideline, was first introduced by the Office of the Superintendent of Financial Institutions, or OSFI, in January 2018.
It was an attempt by the banking regulatory agency to discourage Canadian borrowers from getting in over their heads at a time when the nation's real estate market was both out of control and, because of the massive gains being enjoyed by homeowners, highly seductive.
Under the original stress test, a borrower had to prove they could carry a mortgage at a rate that was either 2% higher than the contract rate or equal to the five-year benchmark rate published by the Bank of Canada, whichever was higher.
The BoC’s five-year benchmark at the time was 4.79%. If your lender offered you an interest rate of 2%, you had to demonstrate an ability to carry the same mortgage at a rate of 4.79% in order to have your loan go through.
Come June, 5.25% — which is several percentage points higher than the rates offered by most lenders today — becomes the new standard.
At the time B-20 was introduced, Royal Bank calculated that purchasing a $500,000 home would require a buyer’s minimum income to be $16,000 higher than what was needed prior to B-20. The bank described the hike as "an impossible rise for many buyers."
But that’s not the case this time around.
Reasons not to panic
A maximum stress test level of 5.25% is not something BMO chief economist Doug Porter thinks homebuyers need to worry about.
"To be clear, this doesn’t increase their actual costs," Porter says. “It just throws up some potential limits on what they can borrow — if they were already borrowing up to the limit, and if they had a downpayment of 20% or more. Even then, we estimate that if a potential buyer’s maximum mortgage had previously been $1 million, now it will be $955,000."
Because these measures will impact all homebuyers, they will lower not only your buying power, but the buying power of competing home shoppers. Porter says that may help cool the overheating in some of Canada’s most competitive markets.
"Think about it this way: If Ottawa gave every renter in the country a $10,000 gift card that could only be used to buy a new home, the only winner from that would be home sellers, not the buyers, because every home price in the country would immediately go up $10,000,” he says. "Think of this as almost the reverse. They are possibly taking away a bit of buying power, but that hurts sellers mostly.”
And it’s not like every lender in the country has to abide by B-20. Alternative lenders, private lenders, mortgage investment corporations (MICs) and provincially regulated credit unions all provide mortgages free of any stress test requirements.
Consider other borrowing options
If you’re accustomed to how banks and large brokerages do business, the alternative space can be a little mysterious, but it’s come a long way in terms of professionalism and transparency in the last few years and has helped lots of people get into homes they may have otherwise missed out on.
"In the last five years, alternative lenders have done more transactions than I’ve ever seen them do," says Danny Ibrahim, CEO of KeyRate Mortgage. "They’ve upped their game."
But Ibrahim warns that you'll pay more in interest and fees.
If you’re going to go the alternative/private/credit union route, iSask Mortgages broker Chris Kolinski advises researching both the broker and private lender you're considering working with before signing any agreement.
“If something feels weird, get a second opinion,” Kolinski says. He adds that successful private borrowing also requires an exit strategy.
“Don't get into something with private money if you do not confidently have a plan to move on to a traditional A-lender," he says.
What’s the play?
The increased stress test is not expected to lead to a reduction in home prices. Ibrahim expects prices to “stabilize," but both Kolinski and Dominion Lending Centres chief economist Dr. Sherry Cooper expect a preimplementation stampede to the market that will only push home prices higher.
“This will further accelerate the already red-hot spring housing market as buyers get in before the June 1 implementation date,” Cooper says, adding that the same thing happened prior to the original B-20 rollout.
Says Kolinski: "If you were thinking about getting into something later this year, you might want to start the process of finding a home before these changes go into effect." His advice is for house hunters to get preapproved right away.
If you can't beat the deadline, prepare to do some belt-tightening and save more for a down payment.
“If you were preapproved to buy a home for $500,000 with a 20% down payment before the stress test changes, you might only be qualified to buy a $480,000 home after they’re implemented,” Kolinski says. “This means you would need to save up an additional $20,000 to make up the difference.”
There’s no shortage of ways to save a little extra cash. One of the easiest is to use an app that pays cash back on the purchases you make.
Ibrahim says first-time buyers might consider turning to a trusted financial institution to make up for the potential shortfall.
“You have to go to the bank of Mom and Dad,” he says. "That’s typically what’s happening in the marketplace, and I believe it will continue to happen for the next couple of years."
Don't be deterred
The new stress test won't help you get into a home any sooner or easier, but today’s ultra-low mortgage rates just might.
“Rates are so completely, compellingly low,” Ibrahim says. “Everybody’s jumping on the lower rates. Everybody’s refinancing."
So don’t let the hype around the stress test knock you off course. Check your credit score, because the best rates go to the borrowers with the highest scores. If you need to improve yours, it’s better to know now rather than finding out the day you stumble upon your dream home.
Reach out to a mortgage broker with any questions you have. Brokers will know better than anyone how the new stress test will affect your buying power. Find one you’ll feel comfortable spilling your financial guts to, because the more questions you answer honestly, the better picture a broker will have of your overall financial situation.
And if you want a clearer idea of where mortgage costs are heading, Ibrahim suggests paying less attention to the OSFI and instead keeping an eye on what the Bank of Canada does with its rates.
"As soon as you get any wind of the Bank of Canada increasing lending rates, it’s more of an indication of what’s going to be happening in the marketplace,” he says. "If the Bank of Canada raises rates, the banks are going to raise theirs."