The mortgage stress test is flawed because it doesn\

The mortgage stress test is flawed because it doesn't consider income growth

By Newinhomes on May 31, 2019

There’s a mortgage stress test duel underway, and the weapons of choice are reports and open letters. Who will win?

The stress test requires homebuyers to qualify at 2% above their contracted interest rate in order to get a mortgage. This used to only apply to insured mortgages (less than 20% down), but as of the beginning of 2018, it also applies to uninsured mortgages. 

About a week ago, the president and CEO of Canada Mortgage and Housing Corporation, Evan Siddall, published an open letter to the Standing Committee on Finance, defending the mortgage stress test, saying it’s doing exactly what it was intended to do. 

Siddall also put some real estate industry members of blast, saying they are self-interested parties who benefit from home sales, so their opinions aren’t to be trusted. He said uninterested parties, like CMHC, Bank Of Canada, and the IMF are trusted resources regarding this type of policy. 

Just a few days later, Will Dunning, Chief Economist, Mortgage Professionals Canada, released a report called “The False Binary,” defending the real estate industry and criticizing the government for not addressing the proposed modification of the stress test.

The “false binary” that Dunning alludes to is the idea that the debate revolves around two options: stress test vs. no stress test. That’s not the case, he says. According to the report, “no serious person” is saying the stress test should be eliminated, but the government is treating the debate this way. 

Dunning’s main point of the report is that the mortgage stress test as it stands does not account for income growth. 

He writes: “If income grows by 2% per year (which is less than the long-term average), the combined effects of higher income and reduced principal, with a 2-point rise in the interest rate in five years, could be assessed today by setting the stress test at 0.75 points above the contracted interest rate.”

The way the stress test is currently structured is based on the unlikely event that interest rates rise, but income does not. If interest rates rise, it’s most likely because of a strong economic environment, which means incomes would probably be higher. It’s not a strong economic environment if income is dropping.     

Dunning also points out that just because someone has a “special interest” doesn’t mean their opinion is wrong. Mortgage professionals, builders, developers, real estate agents - it’s their job to sell homes, but also their job to understand how mortgages work. They have on the ground expertise that is valuable. 

The False Binary concludes with: “One of the greatest risks to the Canadian economy is a policy error that causes house prices to fall and thereby (and totally unnecessarily) causes an economic recession that does great harm to hundreds of thousands of Canadians. I worry about that.”

Read the whole report here

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