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We all knew it was coming, but now the reality sets in.
The ruler of Canadian banking (OSFI) has solidified a rule change that’ll impact more mortgagors than any rule we’ve seen to date.
Here’s a synopsis I wrote for the Globe and Mail if you need a quick summary. The gist is this: Effective January 1, 2018, anyone with 20%+ equity who wants a low rate will have to prove they can afford payments at a rate that’s at least two points higher.
Here’s a few other tidbits of note:
- OSFI’s new stress test will curb buying power (up to 18%) for the roughly 1 in 6 uninsured purchasers it affects
- OSFI’s change will tack on 6-7 percentage points to the average borrower’s gross debt service (GDS) ratio—a measure used by lenders to gauge whether you can handle your payments
- Very generally speaking, the maximum GDS ratio is currently 39% for a well-qualified borrower
- It’s not just about purchases. For a meaningful minority, it’ll also get harder to refinance and renew with a new lender
- Refinancers who need to consolidate debt into a mortgage could be especially challenged because their debt ratios are usually above average to begin with
- It also becomes tougher to qualify for a home equity line of credit (HELOC) with banks, assuming the 200 bps stress test is greater than the current “benchmark rate” stress test at the time you apply
- Today most people qualify for bank HELOCs at 4.89%. On January 1, assuming rates don’t change, they’d qualify at 5.70%.
- A number of Bay Street analysts are now calling for weaker home prices and a roughly 10% drop in bank mortgage originations in 2018
- There’s a chance banks could loosen their debt ratio limits, or make more debt ratio exceptions, to partially counteract the stress test, said National Bank Financial in a report today. But OSFI is watching banks, so there’s only so much they can do.
- Some analysts, like TD Securities, predict non-prime lenders could shed 20% of their business next year
- We don’t necessarily buy this. Yes, alternative lenders will be stung by the stress test (because their rates are higher, which makes their stress test stricter), but that is largely offset by the fact they also:
- are beneficiaries of more bank turn-downs
- permit higher borrower debt ratios (e.g., up to a 50% total debt service ratio vs. the 42% norm)
- allow more non-traditional income than banks (like deposits showing on the bank statements of self-employed borrowers)
- offer longer amortizations, which lower debt service ratios
- could potentially cut rates to help people qualify–and then tack a fee onto the mortgage
- We don’t necessarily buy this. Yes, alternative lenders will be stung by the stress test (because their rates are higher, which makes their stress test stricter), but that is largely offset by the fact they also:
- OSFI’s announcement could be the best news of all time for many private lenders, mortgage investment corporations (MIC) and small non-prime lenders who don’t rely on bank funding, for they won’t be subject to OSFI’s stress test. The top such lenders will see:
- Record application volumes
- A much more qualified (lower risk) borrower than they’re used to seeing
- Higher interest rates to match the higher demand
- An eventual flood of new capital from investors chasing higher yields
- The few lenders, like B2B Bank, that still offer 35-year amortizations will be inundated with business and likely charge higher rate premiums for long-amortization mortgages.
- “The share of low-ratio mortgages with amortization periods longer than 25 years is…increasing, reaching more than half of all borrowers,” said the Bank of Canada in June. Because of OSFI’s decision not to stipulate a 25-year amortization for qualification purposes, two things will happen:
- Even more people will now amortize for longer
- Banks will retain a competitive edge over non-deposit-taking lenders who have higher funding costs for 30-year amortizations. The net effect to consumers: higher rates on these mortgages.
- This could be the busiest December in years for realtors if skittish sellers rush to list and buyers rush to firm up offers before the change kicks in
- Prices on detached homes over $1 million will come under further pressure because of these rules. But condos under $1 million should hold up well. Buyers shut out by the stress test have to buy something.
Some analysts, like TD Securities, predict non-prime lenders could shed 20% of their business next year
Jeremy Rudin
Defaults on uninsured mortgages, even in frothy markets like Toronto/Vancouver, are already well below the national and historic averages. But in his press conference today, OSFI head Jeremy Rudin reiterated that “strong underwriting makes housing more stable.”
Few can argue with that.
But too much of a good thing can be too much of a good thing. If bank underwriting is so stringent that it pushes people into high-cost debt with unregulated lenders, and threatens their very retirement, that stability which regulators celebrate comes into question.
Sidebar: OSFI is clearly prescribing demand-side medicine (qualification tightening) for a largely supply-side (housing shortage) problem. Debating the efficacy of that treatment is something we haven’t done here, but it’s a debate worth having.
15 Comments
Thanks for the insight into these changes. I’m confused though, does this affect existing homeowners who will be refinancing? Will they have to qualify at the higher rates too?
Yes indeed. If you’re purchasing a new home, changing lenders or increasing the risk of your existing mortgage (e.g., adding more borrowing, extending the amortization, etc.) then you need to requalify and the new stress test will apply.
This is a key sentence: But too much of a good thing can be too much of a good thing. If bank underwriting is so stringent that it pushes people into high-cost debt with unregulated lenders, and threatens their very retirement, that stability which regulators celebrate comes into question.
Do you believe provinces will take OSFI’s approach and regulate the NFRFIs?
OSFI has been speaking with provincial regulators about the stress test, but they won’t say any more. The highest probability is that provincial regulators just monitor their lenders for now. If too many higher indebted debt borrowers are getting qualified at the contract rate, the provinces could act later.
Why are changes always on mortgages. Credit cards, car loans, unsecured lines of credit are easier to get. With the minimums and rates higher, most people never payoff.
Credit sets prices. People will not flood bad lenders, prices will fall. They should limit mortgages to 15 years.
A lot of things set prices, not just credit.
A 15 year mortgage limit is just silly. If mortgages were capped at 15 years what do you think would happen to rents, georgist? Think about how ridiculous that idea is.
Housing is a zero sum game. You either buy or you rent, and if you rent then someone else first has to buy that property, so that you can then rent it.
Re: Sidebar (which I agree is a discussion worth having):
The Ryerson City Building Institute disagrees with your assertion that the problem is largely a supply-side one, at least for the Toronto market. They released this paper half a year ago: https://www.citybuildinginstitute.ca/wp-content/uploads/2017/05/Policy-Paper-In-High-Demand-Final.pdf
A short reply won’t answer this big a topic, but here’s a few points:
Supply is not a problem everywhere, just in the locations where people want to buy the most.
According to the Centre for Urban Research and Land Development at Ryerson University, there’s been “a marked mismatch” between the types of units completed (condos) and the types demanded (“ground-level” homes, which are preferred by the large majority of homebuyers).
Using Toronto as just an example, the number of single-detached homes in Toronto is up about 13% over the past decade. The number of households formed is up 19%.
Buyers have reacted by bidding up single family homes much more than other property types. This is a rational move given their alternatives and nothing new. We’ve had considerable price inflation for years. Those worried that home prices are too high have largely the the laws of economics to thank. If supply could satisfy the right type and location of demand, price growth would be much closer to the long-term norm.
I have a new home being built. It has been delayed and will fall into next year. We did the pre approval earlier and everything was ok. So we waived our condition of finance. Now a years later, I am wondering if my deal will be subject to the stress test?
Jason, out of curiosity which lender are you with? And what are they saying in terms of whether you will have to re-qualify under the new stress test?
Hi,
I currently own a home but am trying to upsize. Do you recommend selling the home first and buying a few months later since home prices are predicting to drop? What would happen if I purchased a new home but can’t sell my current home in 2017 and prices drop in 2018?
Hi Eddy, Two questions apply to people in your situation:
1) Can you handle the carrying costs of both homes?
2) Do you qualify for a mortgage on the new home if you still have to carry the old home?
If the answer is no to either question, you’re safer selling your current home first, regardless of what prices do in 2018.
Hi,
Need to renew my mortgage soon and my bank is offering me 3.45% for 5 years fixed rate. Currently at 2.99% would I need to go through the stress test if I wanted to go through a broker at a lower interest rate?
Mark
@Mark, Nope. You could get at a slightly lower rate without the stress test. It would be a credit union lender.