Prime Minister Justin Trudeau has asked his Finance Minister to consider recommendations for making the mortgage stress test “more dynamic,” after widespread criticism of its design.
Mr. Trudeau released his mandate letters for cabinet ministers on Friday, and included the following order for Finance Minister Bill Morneau: “Review and consider recommendations from financial agencies related to making the borrower stress test more dynamic.”
Mr. Morneau “will consider adjustments if economic conditions warrant to support housing access while safeguarding financial stability,” a Department of Finance spokesman said in a statement.
The real estate industry has long pushed for changes to the stress test, but experts have warned that easing its requirements could risk pushing up home prices and increasing household debt. During the federal election campaign, the Liberals’ election platform did not say the stress test would be up for review, although the Conservative Party did.
“Given the context of a minority government, we should not be shocked [the Liberals] are giving it some consideration,” said Robert Hogue, senior economist at Royal Bank of Canada.
In 2016, the Department of Finance imposed a stress test on insured buyers, or those who typically make a down payment of less than 20 per cent of a home’s purchase price. The test is intended to gauge whether borrowers can afford their mortgage payments at higher interest rates, and arrived after a decade-plus of substantial borrowing by Canadian households.
Despite the move, home prices continued to rise, particularly in the frothy markets of Toronto and Vancouver. Subsequently, in 2018, Canada’s banking regulator imposed a stress test on uninsured buyers who make larger down payments. Known as B-20, the test is cited with improving the credit quality of home buyers.
However, the B-20 test is also credited with contributing to a slowdown in real estate activity, while critics have said it is far too simplistic and blunt in its current design.
“[The stress test] should be much more flexible,” said Benjamin Tal, deputy chief economist at Canadian Imperial Bank of Commerce.
Mr. Tal said the test should be more responsive to where Canada finds itself in the interest-rate cycle. As it stands, some uninsured buyers are tested at their negotiated contract rate, plus two percentage points.
While that buffer may be appropriate at low interest rates, Mr. Tal said it could prove harsh when rates are at elevated levels.
“Be aware of where you are in the economic cycle, and design a test that takes this into account,” he said.
The B-20 test was also roundly criticized for how it dealt with existing mortgage holders. Under current rules, people are subject to the stress test when switching lenders, but not if they stay with their current lender. This can prevent people from switching lenders for better terms.
Robert McLister, founder of mortgage comparison site RateSpy.com, said this was a “terrible oversight” worth correcting.
Any changes would need to avoid encouraging risky borrowing. Canada’s household debt burden (the ratio of credit market debt to disposable income) rose to 175.9 per cent in the third quarter, from 175.4 per cent, Statistics Canada said Friday.
“I think the Finance Minister is going to be extremely cognizant of any additional risk his department’s changes could cause,” Mr. McLister said.
Evan Siddall, chief executive of Canada Mortgage and Housing Corp., also weighed in, saying on Twitter Friday afternoon that making the stress test more dynamic is “an important potential refinement.”
“I do not read it to say ‘roll back’ the stress test nor ‘ease’ it, necessarily,” he wrote.
With a report from Bill Curry