The Mortgage Stress Test: A Pillar of Canadian Regulation
The mortgage stress test is a prudential measure that constitutes one of the most important mechanisms in the Canadian mortgage market. Its objective is to ensure that borrowers have sufficient financial cushion to absorb potential interest rate increases. By requiring qualification at a rate higher than the contract rate, the test protects both borrowers and the financial system against default risk in a rising rate environment.
Timeline of Changes
- October 2016: Introduction for insured mortgages: The fédéral government imposes a minimum qualifying rate for all insured mortgages (down payment less than 20%). Borrowers must qualify at the Bank of Canada benchmark rate (approximately 4.64%) rather than their contract rate.
- January 2018: Extension to uninsured mortgages (B-20): OSFI revises Guideline B-20 to require that uninsured mortgages (20% or more down payment) also be subject to the test. The qualifying rate is the higher of the Bank of Canada benchmark rate and the contract rate plus 2%.
- June 2021: New fixed floor of 5.25%: OSFI replaces the Bank of Canada benchmark rate with a fixed floor of 5.25%, judging that the old benchmark was too low and no longer adequately reflected risk. The test now requires qualification at the higher of 5.25% or the contract rate plus 2%.
- December 2024: Exemption for lender switches: The fédéral government announces that borrowers renewing their mortgage with a new lender will no longer be subject to the stress test. This measure promotes competition among lenders and gives borrowers more flexibility at renewal.
Concrete Impact on Quebec Borrowers
To illustrate the impact, consider a Quebec household with an annual income of $100,000 and no other debt. With a contract rate of 5% over 25 years, the maximum loan amount would be approximately $440,000 qualifying at the contract rate. With the stress test (qualifying at 7%), this amount drops to approximately $360,000, a reduction of about 18%. For a first-time buyer in Montreal or Quebec City, this difference can be decisive in choosing a neighbourhood and property type.
Strategies for Brokers
Mortgage brokers must clearly inform their clients of the stress test implications from the start of the process. Several strategies can maximize borrowing capacity within the test framework: extending the amortization period to 30 years (for conventional mortgages), paying off consumer debts before applying, including a co-borrower's income, and considering a variable-rate mortgage if the contract rate is lower (the test still applies, but the lower starting rate can result in a more favourable calculation when the 2% buffer is used). Since the renewal exemption, brokers can also help existing clients switch to a lender offering better terms without the stress test constraint.
The Stress Test and Desjardins Caisses in Quebec
Desjardins caisses, while regulated by Quebec's Autorite des marches financiers (AMF) rather than fédéral OSFI, apply the stress test voluntarily. This practice is driven by two factors: first, mortgage insurers (CMHC, Sagen, Canada Guaranty) require the stress test for all insured loans regardless of lender; second, Desjardins has chosen to apply the same standards as fédéral banks to maintain prudent underwriting practices. For Quebec mortgage brokers, this means the stress test applies uniformly whether the loan is placed with a major bank or a Desjardins caisse. Only certain private and alternative lenders, not subject to OSFI regulation or insurer requirements, can offer qualifications without the stress test, but at significantly higher rates.
Outlook for the Stress Test
The stress test is regularly subject to political and professional debate. Some industry players advocate for easing, arguing the test excessively restricts homeownership access in a high-price context. Others maintain the test fulfilled its role by protecting borrowers and the financial system during the rapid 2022-2023 rate increases. OSFI periodically reviews the 5.25% floor rate and could adjust it based on evolving economic conditions. Brokers must follow these developments to anticipate changes in their clients' borrowing capacity and adapt advice accordingly.