Think stress tests are a bad thing? You clearly have no idea who it’s stopping from buying. Bank of Canada (BoC) numbers show stress tests may have stopped a large number of borrowers from getting in over their head. Almost immediately after stress tests were implemented in both high and low ratio mortgages, the market saw a dramatic decline of borrowers buying “too much” house.
I Totally Know What A Loan-To-Income Ratio Is, But Just Explain It Again…
Have you ever heard that a home should be 2-3 times your income? Of course not, most of you are Canadian. Financial experts suggest a mortgage about 2x your income, and no more 3x. That number is called a loan-to-income (LTI) ratio, and is the size of a loan compared to the income behind it.
In Canada, the LTI rule was twisted by the mortgage industry into your payments should be a third of your income. The switch allowed people to accept increasing debt loads, as interest rates fell. That idea wouldn’t be terrible in a country with fixed rates for the whole duration of the mortgage – like the US. However, it can become a bit of a problem when interest rates are on the rise, and you’re likely to renew at a higher rate.
Regulators haven’t forgotten the 4.5x max rule, and have been watching households with an LTI over 450%. These borrowers are called “highly indebted” at the BoC, and are people that bought “too much house.” That is, they’re taking out a loan disproportionate to the income they make. Rates are just off of record lows, but that increases the odds of experiencing higher debt servicing costs in the not so distant future. Households with high LTIs will have the hardest time adapting to higher payments. That’s precisely why most mortgages in Canada are now stress tested, to eliminate highly indebted borrowers.
Total Borrowers With Loan-To-Income Ratios Are Down Over 11%
Since stress testing was implemented, highly indebted borrowers have been disappearing. Only 16.58% of mortgages went to this segment of borrower, down 11.09% from the previous year. Peak borrowing in this segment occurred in Q3 2016, and we’re now 12.13% lower from that number. To see how stress testing saved many households from financial suicide, let’s break it down by implementation.
Canadian Mortgages To Households W/LTIs > 450%
The percent of mortgage originations to households with loan-to-income ratios higher than 450%.