CIBC report suggests B-20 mortgage rule is driving Canadian homebuyers to alternative lending market

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      For the second consecutive day, a high-profile economist has called for a rethink of the B-20 mortgage stress test.

      Benjamin Tal, deputy chief economist with CIBC World Markets, has written a paper recommending that regulators revisit a requirement that prospective homebuyers qualify for mortgages 200 basis point higher than the contracted rate.

      Part of the reason, according to him, is that this regulation is leading more borrowers to rely on "alternative lenders".

      "Alternative lending is an integral part of any normally-functioning market," Tal wrote. "But a fast-growing alternative lending market is not.

      "Behind the scenes, there is a transfer of risk from the regulated to the less regulated segment of the market—from where there is light to where it is dark," he continued. "That was certainly not the intent of B-20, and any other mortgage-related change to regulations."

      On April 15, the chief economist of the B.C. Real Estate Association, Cameron Muir, linked the B-20 stress to "near recession-level housing demand despite the province boasting the lowest unemployment rates in a decade".

      The "B-20" rule was introduced in January 2018 by the Office of the Superintendent of Financial Institutions in response to Canadians' high debt levels.

      In December, the Canada Mortgage and Housing Corporation stated that the debt-to-income ratio in Metro Vancouver was 242 percent—the highest in the country. Metro Toronto was in second place at 208 percent.

      Tal's paper noted that it's possible to get a fixed-rate mortgage nowadays at 3.5 percent, but a person must still be qualified at 5.5 percent.

      "There is little doubt that the architects of B-20 had Vancouver and Toronto in mind when they designed the new rule," Tal wrote. "The more stretched you are, the more likely you are to fail the test."

      That is indeed what has happened in those two cities, according to research he pulled together from his bank, the real estate industry, Statistics Canada, and the Canada Mortgage and Housing Corporation.

      Sales in Metro Vancouver, in particular, have plummeted over the past year.

      "The damage to the housing market was directly linked to unaffordability," Tal declared.

      He pointed out that 21 policy changes related to the residential mortgage-lending market in the period leading up to the introduction of the B-20 stress test have significantly improved the overall quality of credit in the Canadian market. But he also noted that this evaluation does not capture credit scores of those who don't rely on traditional lenders.

      And it appears that far more borrowers are choosing this route to pay for their homes.

      Citing data from the Ontario Land Registry, Tal concluded that over the past two years, "mortgage originations provided by alternative lenders rose by a cumulative 27% while originations in the market as a whole fell by 11%."

      He acknowledged that this might not be entirely due to the B-20 regulation.

      It would also "reflect the impact of the stress test that was imposed on high-ratio mortgages in late-2016 as well as regulatory-related credit restrictions on new immigrants and those self-employed".

      "The stress test imposed on the market was probably necessary, since there was a need to save some Canadian borrowers from themselves," Tal wrote. "But is 200 basis points the right number?"

      In answering that question, he stated that the B-20 rule was introduced in a slowing housing market. Since then, the Bank of Canada has increased its rates by 75 basis points and the five-year mortgage rate has gone up by 35 basis points.

      "Furthermore, borrowers' income is likely to rise during mortgage terms," Tal noted. "Average personal income has risen by a cumulative 12.5% over the past five years—the stress test does not take that into account.

      "Nor does B-20 allow for the fact that during the course of the mortgage term, equity position rises due to principal payments."

      For these reasons, he called for a "more flexible benchmark" with potentially a narrower spread over the contract rate.