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Did the new Canadian Mortgage Stress Test Cool the Market? Early Indications

When you hear the words new Canadian mortgage stress test, what first comes to your mind?

For many Canadians, the words ‘stress test’ evoke feelings synonymous with its name. Without looking into the details, it may seem like the federal government has simply made owning or acquiring a mortgage more challenging. But this is not the case.

The new stress test implemented on June 1st, 2021, raised the minimum financial bar that anyone must meet to secure a mortgage. This means testing your income at a rate two full points higher than the borrower’s mortgage rate. Even If the mortgage rate is 2.14, you will still be tested at a rate of 5.25 percent. [1]

This doesn’t increase the cost of your mortgage, rather, it ensures that buyers have the financial strength to cover a rise in interest rates. It also means that investors looking to purchase multiple properties and leverage debt will have a harder time doing so in the Canadian market. After an intense boom in the market, it was intervention much needed—but did it change anything?

There were signs that the market was cooling prior to June, so how much did the new stress tests douse the fire and flames?

Let’s look at the data.

June marked the third-straight month with slowdown activity 

The figure above displays the three-month downtrend from the record-setting month in March. After the stress test was implemented, home sales fell 8.4% month over month in June. [2] So, the data alone suggests that the new stress test played a role. However, we must consider that home sales were already trending downward from the insanity of March. From April to May, we witnessed a comparable drop in sales to the June decline. And rom March to April, the markets experienced an even bigger fall-off.

“While there is still a lot of activity in many housing markets across Canada, things have noticeably calmed down in the last few months. There remains a shortage of supply in many parts of the country, but at least there isn’t the same level of competition among buyers we were seeing a few months ago.” - Cliff Stevenson, Chair of CREA

Looking at it from a cultural lens, the pandemic forced a shift in people’s priorities. Especially when things started to open again for the summer. Canadians get maybe three months of summer, so many homeowners pushed back selling or looking for a home until the end of the nice weather. And who can blame them? Beaches, parks, zoos, and the most beautiful places in this country are most enjoyable now. There’s no time to waste.

Mortgage stress tests cool market further into July

In July, home sales dropped for the fourth consecutive month. However, the 3.51% drop in July is the smallest of four consecutive declines. [3] This could indicate that the full-free-fall in home sales could be slowing. Across the country, the moderation of sales activity continues to attract the attention of  REALTORS®, homeowners, and homebuyers. But this was expected after unsustainable levels of activity in March, and experts warn that the record-low inventories should be the focus instead. The markets are still extremely unbalanced, with most of the country in a seller’s market. [4]

“…we are only returning to where we were before COVID, which was a far cry from normal. The problem of high housing demand amid low supply has not gone anywhere – it’s arguably worse. And after years of everyone agreeing that medium-density housing was the future, we are still referring to it as the ‘missing’ middle.” - Cliff Stevenson, Chair of CREA

It's important to note that we are just now making it back to the place we were before COVID. It’s also safe to say that the new mortgage stress test rules likely have played a factor towards cooling unsustainable market activities.

The question is: how long will the fire be held at bay?

 

Final thoughts & decreased mortgage quality

When the pandemic first took its hold, the government looked to save the real estate market. Homeowners had more flexibility on their mortgage payments and interest rates were reduced to jaw-dropping lows. But their efforts didn’t just save the market, they sent the market soaring uncontrollably.

A wave of buyers with no fear of overpaying or extending their debt flooded the market in March.  However, when interest rates do inevitably rise, some buyers will be forced to cover costs that are sometimes over their budget. Canada has historically been conservative when it comes to mortgage lending, but the Bank of Canada has pointed to a deterioration in mortgage quality. Households with a loan-to-income ratio of over 450% represented a record share of mortgage debt in 2020. [5]

The new mortgage stress test may have cooled sales activity, but only time will tell the impact these measures will have on curbing the deterioration of mortgage quality and the overall health of the real estate market.