The controversial mortgage ‘stress test’ is what requires borrowers to qualify for a mortgage based on a higher rate than their contract rate (the rate the mortgage payment is based on).    It requires you to qualify based on the higher of the benchmark rate, which is currently 5.19%, or 2% above the contract rate, whichever is higher.  As of right now, the lowest 5 year fixed rate is 2.54%*.  2.00% above this rate would be 4.54%.  As this is lower than the benchmark rate of 5.19%, the benchmark rate would be used for your mortgage qualification. 

For purchases with less than 20% down payment, it’s always the benchmark rate that is used.

While the stress test has been widely criticized by the mortgage and real estate industries, it serves a valuable purpose.  It was introduced to cool a red-hot real estate market, particularly in the Greater Toronto and Greater Vancouver areas.  Up until mid-2017, these markets were out of control, so it’s understandable that government action was needed before real estate became too out of reach for first time homebuyers. 

What Are The Proposed Changes?

This part is still unclear.  Last week, Trudeau asked Canadian Finance Minister Bill Morneau to “review and consider recommendations from financial agencies related to making the borrower stress test more dynamic.”.    

Umm… Okay.  But does this mean exactly? 

The answer is unclear and has not yet been revealed.  Here are some possibilities for now: 

Possible removal of stress test at renewal

As of now, homeowners are required to pass the stress test if they want to switch lenders at the end of their term. If they don’t pass the stress test, then they will have no option but to re-sign with their current lender. 

So why is it that people have to pass the stress test if they want to switch lenders at the end of the term?  What purpose does the stress test serve in this case?   

It prevents many from being able to shop around for a lower rate, which gives lenders an opportunity to charge whatever rate they like on renewing mortgages. 

It provides ZERO benefit or protection to the homeowner. 

It has ZERO impact on the housing market. 

It just forces people who are already tight on their finances to pay a higher mortgage rate, and cuts off any possibility of shopping for a lower rate. 

As most mortgages are held by the big banks, This enables the lender to retain business, and charge whatever rate they like.  They know there are no other options for the borrower in this case.  This is not as much as a concern for most of the monoline lenders (non-bank lenders who only deal in mortgages), as all their rates are already discounted.  The big banks on the other hand, use posted rates (rates that are much higher than one can expect to pay). This allows the big banks to essentially charge whatever rate they like and still tell the borrower that they are getting a ‘discount’.  Right.    

Note that this doesn’t necessarily mean that they WILL charge an inflated rate… but there is nothing stopping them from doing so.

Advantage = banks. 

Can you guess who sets the benchmark rate?   

You guessed it. The big 5 banks.  The benchmark rate (stress test rate) is an average of the big 5 banks posted rates.  Not fair to many people… but hey, the banks are profiting.

Possible lowering of stress test rate

It could also mean that they will lower the benchmark rate to allow for people to qualify for higher amounts, although I doubt they would implement this across the board (if at all). 

Perhaps they will consider lowering it only for first time homebuyers, which would make it easier for them to get into the market.  Or perhaps they will only require it in larger markets, such as the GTA or GVA.  Maybe they will remove it in housing markets that are not exposed to the same level of market fluctuation seen in larger markets.  I doubt they will do this as well, as this would then offer no protection against rising rates for those who are applying for the maximum mortgage they qualify for.  If rates were to increase, then these people may find it difficult to make their payments, which could place them in financial hardship.  The stress test significantly reduces the risk of happening, which is one of its big benefits.

It will be interesting to see what changes will be made to the stress test… if any at all. We’ll have to wait until sometime in 2020 to find out for sure.

*The 5 year fixed rate at 2.54% is for purchases with 25% or greater down payment.  Purchase price must be under $1 million.

Paul Meredith is the author of the Amazon #1 best selling book, Beat the Bank – How to Win The Mortgage Game in Canada, and has ranked as one of the top 75 mortgage brokers in Canada since 2016. He was a finalist for Mortgage Broker of the Year in 2018, and can be seen as the exclusive mortgage broker on season two of TV’s Top Million Dollar Agent.