Mortgage stress tests have helped prevent a surge of delinquencies in the face of rapidly rising interest rates, according to new research from the Bank of Canada.
In a research note, central bank staffers analyze the impact of the increasingly stringent stress testing policies adopted by the federal government and the Office of the Superintendent of Financial Institutions (OSFI).
The government has mandated stress tests for all insured mortgages since 2016, expanding an existing policy that required stress tests for only certain types of loans.
In 2018, OSFI began requiring lenders to stress test low-ratio, fixed-rate mortgages — a requirement that was later tightened.
Bank of Canada researchers concluded that the OSFI stress testing requirements affected mortgage borrowing, housing prices and households’ financial resilience.
“The 2018 mortgage stress tests — a policy implemented for uninsured mortgages — improved credit quality across the entire mortgage portfolio, as intended. But it also had broader implications since it led to lower mortgage credit and house price growth,” the research paper said.
“Overall, we find that this change successfully slowed down the credit and house price booms. Areas more exposed to the 2018 policy experienced a more pronounced decline in the number of mortgages originated, average mortgage size and aggregate growth in local house prices than less exposed locations did,” it said.
Additionally, the paper found that, while the expanded 2016 stress testing “improved the credit quality of new borrowers,” it didn’t do much to curb the strength of credit and housing markets.
“The 2016 mortgage stress tests — a policy implemented only for insured mortgages — resulted in an improvement in standard measures of credit quality for new mortgages, such as credit scores and the distribution of loan-to-value and debt service ratios. However, due to its narrow scope, this policy had a limited impact on the mortgage market because it did not contribute to slowing down growth in mortgage credit and house prices in Canada,” the paper said.
Still, the research found that the 2016 expansion of stress testing helped guard against higher delinquencies as interest rates rose.
“While the 2016 policy did not manage to halt the credit boom in Canada, it did enhance the credit quality of high-ratio mortgage borrowers, as evidenced by a subdued increase in delinquencies,” the paper said.
“Following the rise in the Canadian policy interest rate, geographical areas more exposed to the 2016 policy experienced a lower increase in credit delinquencies than less exposed areas did,” the paper said. “This difference is particularly pronounced for delinquencies on credit cards and auto loans and for borrowers holding mortgages with LTV ratios above 80%.”
And, while some borrowers may have turned to alternative lenders for mortgages in response to the 2016 policy shift, the researchers found that the expansion of stress testing for insured mortgages, “bolstered the overall resilience of the system… Consequently, mortgage rate stress tests have fortified the ability of borrowers, especially those with high-ratio mortgages, to better navigate significant increases in mortgage payments.”
Overall, the research concluded that mortgage stress tests have helped to promote financial stability and “ensure households can manage increases in mortgage payments without falling behind on their credit obligations, even amid challenging economic conditions.”