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CAVEAT NO. 2: AS IT TURNS OUT, THE STRESS TEST HAS SERVED A PURPOSE

For those of us in expensive housing markets that are doing all we can to be able to afford a home that meets at least some of our needs, the mortgage “stress test”—a colloquial term for federal rules that effectively restrict the dollar amount financial institutions can lend to borrowers—has been something of a pariah.

The amount of money homeowners can borrow is determined by a variety of factors, including (primarily) the borrower’s income, the size of their downpayment, the length of their mortgage amortization (e.g. in how many years the mortgage will be fully paid), and the interest rate on offer. The higher the rate, the less one can borrow (all else being equal); the lower the rate, the more one can borrow. The stress test works by “qualifying” borrowers at an interest rate that’s higher than the one actually on offer, typically by 2 percentage points. As an example, if today’s rate is 5.19%, the amount of money a borrower can access will be determined, in part, by using an interest rate of 5.19% + 2.00% = 7.19%. The purpose of the stress test is to limit risk to the financial system (and to households) of rising interest rates; on the whole, it’s quite reasonable in its construction and application.

When rates were low and falling, many questioned the need for such a high (interest rate) hurdle to be cleared by borrowers, especially in Canada’s most expensive markets. Today, the prior application of the stress test to homeowners that are currently renewing their mortgages has done its part to ensure that borrowers can continue to afford to live in their homes, despite the much higher cost of money. For instance, while today’s 5.19% 5-year fixed mortgage rate is two whole percentage points higher than the rate most are renewing from, it is precisely the rate that many were qualified at five years ago. In other words, the stress test was built for market conditions that we’re experiencing now. 

This is not to say that renewing at higher rates doesn’t come with a downside: for the vast majority of renewers it means higher payments, necessitating a reallocation of spending and saving for some, and for others requiring more strategic financial management to ensure continued affordability—even if their incomes have been rising over the years.

With 

(and 

), how—and how much—interest rates change will be a point of continued interest for all of us, with implications for household saving and spending, the labour market, and, of course, our housing markets.45% of all outstanding Canadian mortgages set to renew in the next two years60% in the next three