The problem with the Canadian government’s mortgage stress test

On a recent segment of BNN Bloomberg, Toronto realtor John Pasalis voiced support for extended mortgage stress testing nearly a year to the day after the federal government introduced it.

“The stress tests are great,” Pasalis says of the measure which requires mortgage applicants to qualify for their loans at a higher interest rate than they are signing on for.

As he sees it, there’s just one problem. “The problem is, it was probably too much, too quick.”

The new mortgage rules have come at a time when mortgage rates are on the rise. Pasalis, president of the Realosophy brokerage, notes how the Bank of Canada has hiked the overnight rate five times over the past six quarters. That, together with the stress testing, has added 300 basis points to the qualifying rate for homebuyers.

Pasalis highlights how much the lending landscape in Canada has changed for borrowers over the past 10 years.

“Policymakers thought extending credit to households was a great idea,” says Pasalis, noting that a decade ago consumers had access to 40-year amortizations.

Today, amortizations are capped at 25 years and a stress test has come with higher interest rates.

“I think it’s a lot in a relatively short period of time, especially over the past 18 months, to introduce these measures, and I think you can’t sort of shift the underlying philosophy of how you’re lending to consumers significantly without there being consequences,” says Pasalis.
The stress test has been commonly cited as one of the main causes of the Canadian housing market cooldown that played out last year. Experts have estimated that the stress test eats away at a mortgage applicant’s buying power by about 20 percent.

In commentary posted to Twitter, Pasalis speculated that policymakers may ease stress testing if the Canadian housing market continues on its downward trajectory this year.

Already, he suggests, a significant number of borrowers are turning to private lenders, who typically charge higher interest rates but are not mandated to impose a stress test. “As a result, they are paying much higher rates for their debt, spending less, [and] saving less.”