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STRESS TEST QUALIFYING RATE LOWERED BY THE BANK OF CANADA

The stress test qualifying rate was lowered 15 bps by the Bank of Canada.  The new rate is 5.19%, down from 5.34%.  This is a modest move when you consider Canada’s 5-year bond rate has declined 106 bps from recent highs. 5-year Bond Yield

It’s the first change in the Benchmark posted 5-year rate since May 9th, 2018.  It marks the first decline since Sept. 7th, 2016.

WHY THIS MATTERS

The benchmark rate (a.k.a., the stress test rate or “mortgage qualifying rate”) is used by Federally regulated lenders to qualify borrowers.  A mortgage applicant must prove they can afford the higher stress test rates, should rates rise.  Quite simply, they bake in a 2% or greater interest rate increase when they calculate your debt service ratios.

HOW MUCH MORE BUYING POWER DOES THIS MEAN?

For borrowers buying a new home with less than 20% down, the drop in the stress test rate means:

  • Someone making $50,000 per year can qualify for $2,800 (1.3%) more home
  • Someone making $100,000 per year can qualify for $5,900 (1.3%) more home

* Assumes no other debts and a 25-year amortization *

For borrowers buying a home with 20% or more down, the drop in the stress test rate means:

  • Someone making $50,000 per year can qualify for $4,000 (1.4%) more home
  • Someone making $100,000 per year can qualify for $8,300 (1.4%) more home

* Assumes no other debts and a 30-year amortization*

HOW IS THE STRESS TEST RATE DETERMINED?

This was somewhat unexpected by analysts.  The Bank of Canada uses a complicated formula which they explained as:

“There are currently two modes at equal distance from the simple 6-bank average. Therefore, the Bank would use their assets booked in CAD to determine the mode. We use the latest M4 return data released on OSFI’s website to do so. To obtain the value of assets booked in CAD, simply do the subtraction of total assets in foreign currency from total assets in total currency.”

The BoC explains further:

“Prior to July 15th, we were using April’s asset data to determine the typical rate as that was what was published on OSFI’s website. On July 15th, OSFI published the asset data for May, and that is what we used yesterday to determine the 5-year mortgage rate. As a result, the rate changed from 5.34 to 5.19.”

Clear as mud?  That’s what I thought.

TAKEAWAYS FROM A LOWER STRESS TEST RATE

In my opinion, this won’t have a meaningful effect on house prices.  As the above calculations show, a 15 bps reduction in the stress test only increases purchasing power by 1.3 % – 1.4 %.  It may be a small psychological boost for borrowers but shouldn’t send home prices higher.

If you have questions about the stress test rate, qualifying for a mortgage or anything else, please contact me anytime.