New Uninsured Mortgage Stress Test Starts June 1

Here’s the latest on what we know about the banking regulator’s new mortgage stress test proposal…

12:10 p.m. ET Update

• OSFI has proposed a tougher minimum qualifying rate for uninsured mortgages. As planned, it will be the higher of:
  • the mortgage contract rate plus 2%, or
  • a 5.25% floor rate
• That 5.25% floor is 0.46%-pts higher than the current minimum stress rate of 4.79%. So, for many, it would be harder to get approved for a mortgage than today. But if rates go up, the stress test could actually get easier to pass because then only the increment above the borrower’s actual mortgage rate would apply.
• OSFI intends to “revisit the calibration of the qualifying rate at least once a year to ensure it remains appropriate for the risks in the environment.” (OSFI will seemingly be attempting to time the interest rate and/or housing market. Quite a feat!)
• “The current Canadian housing market conditions have the potential to put lenders at increased financial risk,” OSFI says.
• OSFI is accepting comments on its proposed new mortgage qualifying rate by email to [email protected] before May 7, 2021.
• OSFI says it “will communicate final amendments to the qualifying rate for uninsured mortgages in Guideline B-20 by May 24, 2021, with a coming into force date of June 1, 2021.”
• The Department of Finance says it is expected to make a statement about its insured mortgage stress test “mid-afternoon” today.
• For context on the history of this proposal see the story from yesterday on revisiting the mortgage stress test.

12:35 p.m. ET Update

• At today’s rates, OSFI’s proposal would theoretically cut borrowers’ homebuying power by roughly 4%.
• Clearly, this policy alone won’t spark a lasting bear trend in housing. Far from it, given the demand/supply imbalances out there. But it would certainly add some chill to Canada’s lava-hot market.
• Policymakers knew they needed to deflate some of the manic homebuying psychology we’re seeing across the country, but that wasn’t the stated purpose of this move. OSFI’s proposal, it says, is to protect regulated lenders from “significant loan losses if economic conditions deteriorate.” OSFI explained that banks “can experience losses both through the potential inability of borrowers to meet their debt obligations, as well as through declining values of the real estate properties pledged as collateral in mortgage loans.”

1:05 p.m. ET Update

• OSFI says its new proposed minimum stress test is “risk-based” unlike the one it suggested last year.
• The current stress test is market-based. Banks influence the 5-year posted rate that acts as today’s minimum stress test rate, as well as the actual rates borrowers pay. This new stress test would give the banking regulator direct power to control Canada’s housing market.
• That begs the question, how would OSFI set the new floor rate to ensure it’s not too high (restricting housing demand) or too low (allowing too much demand)?
• The initial 5.25% floor “ensures that the financial system is adequately prepared for the possibility of a return to pre-pandemic economic conditions,” OSFI said. It equals the “average benchmark rate that prevailed in the 12 months leading up to the pandemic…”
• OSFI plans to review the floor rate “at a minimum annually, every December, well in advance of the high-volume…spring season.” Of course, a lot can happen to interest rates between Decembers.

1:55 p.m. ET Update

• There will likely be tweaks to this “proposed” stress test before it takes effect on June 1. OSFI could very well change that 5.25% floor rate to something else, for example.
• Today’s announcement at least partly addresses policymakers’ concern that too many people are taking on too much mortgage debt. The percentage of folks with loan-to-income (LTI) ratios above 450% (the danger zone, according to the Bank of Canada) is at a record 23%+.
• On April 1 CMHC told us the new First-time Home Buyer Incentive (FTHBI) “is still expected for the spring.” This revised program—which is expected to increase first-timers’ buying power in Toronto, Vancouver and Victoria—could potentially offset a stricter stress test for young buyers.
• There may be some front-running of this policy, mainly by folks with high debt ratios who are afraid they won’t qualify come June 1. But the number will be minimal and may be offset by the number who don’t rush to buy (because they fear a market top).
• OSFI included this seemingly innocuous statement at the bottom of its letter today: “OSFI will be looking for heightened vigilance from FRFI lenders in applying the principles of Guideline B-20 related to collateral management, income verification and debt servicing, combined Mortgage-HELOC loan plans and risk governance.” In other words, expect fewer debt ratio exceptions at federally regulated lenders (i.e., it will get additionally harder to qualify for borrowers at the very margins.)

2:35 p.m. ET Update

• OSFI head, Jeremy Rudin, addressed reporters just now, saying:
  • OSFI is concerned about what it’s “seen in the market” and chose the higher 5.25% rate because “the system needs to be ready for a return to pre-pandemic levels.”
  • “..The main thing we have to be ready for is an increase of mortgage rates in the pre-pandemic range…It’s possible….that [rates are] extraordinarily low because of the pandemic.”
  • The originally proposed stress test from last year would have proved “too volatile to be practical in the housing market.” Rudin said it would have been hard for borrowers getting pre-approvals to know what they could afford.
    • We’re not sure this is a great argument against a market-based stress test rate, because the pre-approval floor rate could easily be locked in at the time of application.
  • When asked if an insured stress test was coming, Rudin replied that he is “not able to speak for” the Finance Minister and that in the long history of policy adjustments, insured and uninsured changes “have often been done at different times.”
• OSFI will announce the results of the public consultation on this proposal on May 24.
• Any time the government makes it harder to qualify for a federally regulated mortgage, it creates more demand for non-OSFI-regulated lenders. Such “alternative” lenders lend more liberally, but at higher interest rates. This case will be no different. In other words, the government continues to shift higher-risk lending to the less regulated market.
• It’s interesting that OSFI criticized big bank 5-year posted rates on February 18, 2020, saying “the posted rate [benchmark] is not playing the role that we intended…OSFI has observed that these rates are no longer moving in line with actual contract rates.” Yet, the regulator bases the starting floor rate for this new proposal on a 12-month average of 5-year posted rates.

4:50 p.m. ET Update

• The Minister of Finance has thus far not announced any change to the stress test on default insured mortgages. Insured borrowers must still prove they can afford payments at the benchmark rate (currently 4.79%).
• The Minister made this statement today: “We will continue to monitor housing market conditions across the country. To inform potential steps the government may take, we will closely examine the results of the consultation announced by the Superintendent of Financial Institutions.”
• OSFI didn’t comment on this but mortgage approvals by May 31 will almost certainly be based on the current stress test, even if the closing date is in June or later.
• We’re still assessing the potential side effects of today’s announcement. Here’s one. Currently, multiple banks make debt ratio exceptions for strong clients. For example, a client purchasing a home with considerable equity (e.g., a down payment of 35%+), excellent credit and sufficient net worth may be approved, despite having a 50% total debt service (TDS) ratio. The normal limit is 44%. OSFI’s announcement today may curtail those exceptions somewhat. That would be unfortunate because, in reality, these are nearly zero-risk borrowers due to their ability to pay and skin in the game.
• A higher qualifying rate would reduce credit limits of new HELOCs, possibly pushing more seniors into higher-cost reverse mortgages, which aren’t stress tested.

5:50 p.m. ET Update

• OSFI tells us:
  • “Our process is to continually monitor the appropriateness of the rules that we set and to update them accordingly….With respect to the qualification rate…there will be an annual review of the calibration of that rate to recognize conditions can change. We will be publishing an update and a decision at least annually in December to recognize that we’re looking at this actively and incorporating the latest information that we think is appropriate.”