Canada’s banking regulator has proposed changes that would strengthen the stress test applied to uninsured mortgages.
The Office of the Superintendent of Financial Institutions (OSFI) unveiled its proposed changes on Thursday, which would require borrowers applying for uninsured mortgages—typically those with more than a 20% down payment—to qualify at their mortgage contract rate plus two percentage points or 5.25%, whichever is higher.
The stress test currently has a minimum qualifying rate of 4.79%, nearly 50 basis points lower.
Additionally, OSFI said it plans 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 Superintendent Jeremy Rudin said the higher floor rate is based on an average of the qualifying rate in the preceding 12 months leading up to the pandemic, adding that financial markets must be prepared for a return to pre-pandemic conditions—i.e., higher interest rates.
“The main thing we have to be ready for is an increase in mortgage rates to the pre-pandemic range,” he told reporters. “We have interest rates that are extraordinarily low, even by recent standards.”
He added that the regulator is concerned about market conditions, which elicited this warning to lenders in OSFI’s statement: “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.”
“Rather than waiting to see any kind of deterioration in underwriting practices, we’re proactively out there reminding lenders that even in these conditions, the principles that we elucidated in B-20 are very important and that we’re going to be looking closely to see that they’re being respected,” Rudin said.
Reaction to the Proposed Changes
Reaction to OSFI’s announcement was swift, with some saying the increased minimum stress test went too far, while others said it didn’t go far enough.
“Increasing the qualifying rate by another almost 50 basis points will only serve to disqualify more aspiring middle-class Canadians and would-be first-time buyers,” Paul Taylor, President and CEO of Mortgage Professionals Canada told CMT. “While 46 basis points isn’t a tremendous difference, philosophically, we’re continuing with a structure that exacerbates the wealth gap and makes it even more difficult for those without a bank of mom and dad to rely upon to own a home.”
It’s estimated that this proposal would reduce purchasing power for uninsured borrowers by between 4% and 4.5%.
“The maximum amount that can be borrowed under the new rule would decrease by 4.5% (from $442K to $422K for a median-income household),” National Bank economists wrote. In comparison, they noted that the B-20 stress test implemented in January 2019 requiring homebuyers to qualify at the higher of either the 5-year posted rate or the contractual rate plus 200 basis points reduced purchasing power by 22%.
“Though the new measure is a step in the right direction for financial stability, we doubt this alone will significantly cool the housing market,” they wrote.
Still, some see the increase in the stress test’s floor rate as overreach, considering it is already about 300 basis points above some of the lowest uninsured mortgage rates still available today (and even more so for variable rates).
“I am struggling to see how this can be justified as a prudential regulatory measure. Prior to today, the hurdle rate used in the stress test was already far in excess of any credible scenarios for future market interest rates,” Will Dunning, MPC’s Chief Economist told CMT.
“As I commented recently, official data from the Bank of Canada shows that the highest actual average lending rate seen since the start of 2013 is 3.76%. This seems to me to be a reasonable interest rate to use in pursuit of prudent regulation.”
Dunning added that the stress test fails to take into consideration two key factors that will reduce the impacts of higher rates at the time of future mortgage renewals: “Repayment of mortgage principal will be more rapid than is implicitly assumed by the stress tests; secondly, borrowers will experience income growth.”
There’s no word yet if changes to the insured mortgage stress test will be forthcoming as well. But the Minister of Finance, who oversees the stress test applied to insured mortgages, said this: “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.”
The public is invited to provide feedback to OSFI via [email protected], which will be accepted up to May 7, 2021. OSFI will then communicate some of that feedback and any final amendments to the qualifying rate by May 24, 2021, prior to the new stress test taking effect on June 1, 2021.