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How the federal budget could tweak the mortgage stress test

How the federal budget could tweak the mortgage stress test
Business
When the federal government rolled out a mortgage “stress test” last January, it was meant to keep Canadians from taking on more real estate debt than they could afford.

A year in, some critics have said it’s pushed home ownership out of reach for younger Canadians and other first-time home buyers, and would like the test tweaked in Tuesday’s federal budget.

Even Finance Minister Bill Morneau has made vague suggestions in recent months that the Liberals will look at options to make housing more affordable.

Defenders, however, say the stress test, introduced as part of Regulation B20, is working exactly as it should.

“They had to protect borrowers,” said John Andrew, a real estate professor at Queen’s University’s Smith School of Business. “Everybody was borrowing every possible dollar they could.”

Those borrowers “were going to be in trouble if rates started rising,” added Andrew.

In a speech last month, a senior official at the agency that imposed B20 defended the stress test.

“The escalating cost of homeownership in Canada, and its knock-on effects to the economy and to society, is a problem — and it’s a problem that is proving very challenging to address,” said Carolyn Rogers, with the Office of the Superintendent of Financial Institutions (OSFI).

“But the answer to this important problem cannot be more debt,” she said. “Particularly, it cannot be more consumer debt, fuelled by lower underwriting standards.”

The stress test, implemented by OSFI, means that borrowers with a down payment of more than 20 per cent have to show they can afford a mortgage (or home equity line of credit) at two percentage points above the rate being offered, or the Bank of Canada’s 5-year benchmark, whichever is higher.

“It’s definitely had an impact, particularly on first-time home buyers,” said Michael Bourque, CEO of the Canadian Real Estate Association (CREA), a trade group representing realtors across the country.

Since the stress test was rolled out, the Bank of Canada has raised its key interest rate three times, by a total of 0.75 percentage points to the current 1.75 per cent. Statistics show home prices have started to drop, albeit slowly.

The impact B20 has had on housing prices isn’t much of a surprise to mortgage broker Robert McLister, who also runs Ratespy.com, a mortgage rate monitoring website.

“When you make it significantly harder for one out of 7 people to qualify, you’re going to see a drop in the market, and that’s exactly what’s happened,” said McLister.

While some critics have called for the stress test to be changed, or eliminated entirely, McLister believes there’s an even bigger obstacle for first-time home buyers, particularly younger people in their 20s and early 30s.

“I think they have to worry more about their incomes stagnating or jobs disappearing, than about the stress test. That’s a much bigger concern,” said McLister.

While he wouldn’t like to see the stress test eliminated, McLister believes there are some easy tweaks to B20 which the government should make Tuesday.

Allowing borrowers to amortize a mortgage over 30 years instead of 25 would decrease monthly payments, giving Canadians more flexibility in case rates rise, McLister argued.

“The longer amortization makes sense for people who can already qualify for the 25 year (mortgage),” McLister said. “Any time you can make things more flexible for borrowers without increasing systemic risk, it’s a good thing.”

Another change McLister would like to see is dropping the stress test exemption for borrowers who stay with their existing lender when their mortgage needs renewing. The exemption discourages shopping for lower rates, he said.

“Why wouldn’t the government want to make it more possible for people to get a better rate? It just makes no logical sense.…You’re also protecting the financial system more by letting people shop around,” McLister added. “A new lender would do the stress test, a full look at your finances, and your employment status.”

CREA’s Bourque said he would like to see the two-percentage point stress test become a hard cap, which gets reduced as interest rates rise. If they go up by a quarter point, the stress test would add 1.75 points.

CREA is also hoping the government will also allow mortgage payments to be completely tax deductible, in the way RRSPs contributions are.

“If the biggest concern is having people paying down debt, let’s treat mortgage payments the same way we treat RRSPs. Instead of putting it into their RRSPs, people can pay down their mortgage,” Bourque said.

Another way to help make home ownership a more realistic possibility, said Andrew, is to raise the amount Canadians can borrow from their RRSP to help make a down payment on their first home. The cap is currently $25,000.

“Make it a generous, meaningful cap, like $100,000. That way, people can have an option,” said Andrew.
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