So much for the adult supervision of our housing market.
The federal government was onto a good thing when it introduced a stress test for home buyers a few years ago that demanded they be able to afford mortgage payments if interest rates spiked higher. The stress test was tough, but all in a good cause, in that it limited the risk of people buying more house than they could properly afford.
Starting April 6, the stress test will get easier for insured mortgages, which typically means the buyer has a down payment of less than 20 per cent. An already hot market in many cities is getting more stimulus through the easier stress test. Prices will rise, affordability will fall and more people will buy homes they can just barely afford. Wait until they add kids, cars and rooms full of furnishings.
The revamped stress test requires that buyers be able to afford payments calculated using the greater of the rate offered by their lender, or a new weekly reference rate based on real market five-year fixed rates for insured mortgages plus a mark-up of two percentage points.
The current stress test is based on posted five-year fixed-rate mortgage rates at the big banks, which are higher than what the banks will offer homebuyers, and now uses a rate of 5.19 per cent. A competitively discounted five-year fixed-rate mortgages today goes for about 2.69 per cent, which means the current stress test is roughly 2.5 percentage points higher than what people are actually paying.
In pure economic terms, that’s an excessively big margin of safety to require from buyers. There is zero risk of rates rising 2.5 points any time soon. With the full impact of the coronavirus, also known as COVID-19, on global economic growth still to be determined, there’s a bigger chance that rates will fall from current levels.
In fact, worries about COVID-19 have helped to cause a drop in the bond market interest rates that guide mortgage rates. Yet, that 5.19-per-cent reference rate for the stress test has held steady.
This resistance to market trends has led to criticism of the current test for being too rigid, and thus causing too many people to rethink their home purchase. The usual choices for these frustrated buyers: Wait and save a bigger down payment, buy a smaller house or find a cheaper neighborhood.
The toughness of the original stress test did slow the housing market, but it’s feeling much better now. The average resale home price nationally surged 11.2 per cent in January over the same month of 2019. Prices jumped 19.5 per cent in Kitchener-Waterloo, Ont., 8.7 per cent in Toronto, 9.8 per cent in Montreal, 11.1 per cent in Saint John and 7.8 per cent in Halifax.
Vancouver is still recovering from a slump, and markets in Alberta and Saskatchewan are still hurting as a result of low oil prices. But there was an overall sense of renewal in the housing market prior to the announcement that the stress test would be softened.
The housing industry has hammered the stress test for being too harsh and for ruining the home-ownership aspirations of young first-time buyers. Just as this argument was weakening amid strong sales, the federal government has stepped in to make it easier to buy a home.
The revamped stress test is better in some ways than what it replaces – more commonsensical and responsive to what’s actually happening to interest rates in the here and now. But the toughness of the current test is what’s needed as housing mania reawakens in many cities.
Forget the idea that the current stress test requires buyers to afford rates at levels they may not see for a decade or more, if ever. The real value is that it forces buyers to save more or borrow less money. To make more conservative home-buying choices, in other words.
Easing the stress test will add fuel to the market and make it less onerous to qualify for a mortgage. Housing needs a firm hand right now, not a more indulgent approach.
PERSONAL FINANCE COLUMNIST
The Globe and Mail, February 18, 2020