Is it time to reconsider Canada’s B-20 mortgage stress test? CIBC’s chief economist Benjamin Tal’s latest real estate report indicates that while the measure has cooled the Canadian market, it’s time to loosen the reigns.
“The stress test imposed on the market was probably necessary, since there was a need to save some Canadian borrowers from themselves,” opens Tal’s April 2019 report. “But more than a year after the introduction of B-20, we are in a position to say more about the impact of that change on the trajectory of the market in general, and alternative lending in particular.”
The B-20 stress test was introduced in January 2018 by the Office of the Superintendent of Financial Institutions (OSFI). It requires potential homebuyers to qualify at two per cent above their contracted mortgage rate (or 200 basis points). The test was designed cool super-heated markets such as Toronto and Vancouver, as well as raise overall credit quality within the real estate sector.
Nevertheless, says Tal, it does not adequately address several market factors: “The average personal income has risen by a cumulative 12.5% over the past five years—the stress test does not take that into account. Nor does B-20 allow for the fact that during the course of the mortgage term, equity position rises due to principal payments. Another shortcoming is that the stress test doesn’t consider mortgage term and the decreasing borrower risk with longer terms selected.”
The report states that B-20 has been responsible for nearly 60% of the overall decline in mortgage originations in 2018, equaling $13-15 billion decline in new mortgage loan values. As such, Tal questions if the test is still appropriate for today’s market conditions, noting, “Is 200 basis points the right number? At the end of the day, there is no real science behind that number … the rule was introduced in an environment of an already slowing market, and that since then, the Bank of Canada has hiked rates by 75 basis points, and the five-year mortgage rate has risen by 35 basis points.”
Additionally, the report suggests that the B-20 stress test is sending more Canadians into the arms of alternative lenders. Stats from the Ontario Land Registry indicate that alternative lenders accounted for nearly 12% of total transactions in the province over the last year (15% in the GTA), which is an increase from their share prior to B-20’s arrival.
“What’s interesting is that the upward trajectory was established in 2017 when alternative lenders accounted for only 8% of new loans. Over the past two years, mortgage originations provided by alternative lenders rose by a cumulative 27% while originations in the market as a whole fell by 11%.”
“Beyond B-20,” it continues, “that might reflect the impact of the stress test that was imposed on high-ratio mortgages in late 2016 as well as regulatory-related credit restrictions on new immigrants and those self-employed.”
The CIBC analysis concludes that now may be time to rethink the test, adding, “We need a more flexible benchmark, potentially a narrower spread over the contract rate when interest rates approach cyclical peak, and perhaps to establish a reasonable floor under which the qualifying rate will never drop below.”
Read the full report.