This post was first published on August 19, 2019, and was updated on October 19, 2023.
UPDATE: On October 16, the Office of the Superintendent of Financial Institutions (OSFI) released its response to industry feedback to proposed changes for its Guideline B-20, the regulations that govern the lending and underwriting practices for Canada’s federally-regulated financial institutions.
According to the feedback, a slew of changes could be coming down the pipe for borrowers as of January 1, 2024, including a new loan-to-income ratio. However, the regulator appears to confirm it will not tweak the criteria for existing GDS and TDS ratios, or exempt renewing mortgage borrowers from being stress tested when switching to a new lender, with the exception of high-ratio, transactionally-insured borrowers, as long as their original mortgage amount or amortization period does not change.
Read our post What changes are in store for Canada’s mortgage stress test? to learn more.
The below information reflects the state of the mortgage stress test as of August 19, 2019. Changes to the mortgage stress test in early 2020 may affect the relevance of information below.
The Office of the Superintendent of Financial Institutions (OSFI) introduced a mortgage stress test that took effect in January 2018. It requires homebuyers to prove they can afford payments of the greater of the Bank of Canada’s five-year benchmark rate (currently 5.19%) or their contract rate plus two percentage points.
The stress test is meant to ensure first time homebuyers and existing owners can handle interest rate spikes.
Evan Siddall, president and CEO of the Canada Mortgage and Housing Corporation (CMHC), recently argued last year’s mortgage stress test should continue to apply to mortgage renewals.
“In a February 2019 speech, OSFI Assistant Superintendent Carolyn Rogers explained why renewals should not be exempted from the stress test. In brief, OSFI doesn’t want to stimulate competition among banks for weaker credits,” Siddall wrote in a letter to the Standing Committee on Finance in late May.
“We can take the thinking a step further. Lenders often engage in pro-cyclical behaviour such as dumping assets in the face of a crisis, especially weaker assets, sending asset values even lower. We wouldn’t want lenders hiding behind the stress test to justify refusing to renew mortgages,” he continued. “OSFI evidently chose a lesser evil: effectively requiring that existing lenders support their existing customers — a practice they will monitor — in a crisis. Inherently, the policy means that lenders must therefore re-price these exposures instead of refusing to renew.”
The problem with Siddall’s argument is that renewers aren’t “weaker” in terms of credit worthiness than purchasers since they have a history of making mortgage payments over the course of their previous mortgage terms.
And if homeowners attain a lower interest rate by shopping around at renewal, it actually reduces their risk of default.
“If there is a better rate out there and the consumer switches to that lender it, in fact, reduces the risk of a default because the monthly mortgage payments are lower,” James Laird, president of CanWise Financial, said.
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One unintended consequence of the stress test is its impact on competition in the mortgage market and owners’ ability to get the best mortgage rates in Canada – particularly for those looking to renew.
Laird argues that the stress test should not be applied to mortgage renewals, as it discourages owners from shopping around for the best possible interest rate.
“The CMHC is defending its position that a stress test be required on a basic renewal. This stance is a detriment for consumers trying to shop around for the best rate at renewal,” Laird said. “Regulation currently requires that the consumer goes through the full mortgage qualification process, including passing the stress test, if they switch to a new lender who may be offering a better rate.
“However, the incumbent lender is not required to follow any qualification process, including not having to apply the stress test.”
Current mortgage qualification rules require homeowners to re-qualify if they want to switch to a new lender at renewal. That means they have to undergo a new credit check, employment verification, appraisal, assessment of non-mortgage debt, and, as mentioned, the stress test.
Meaning current mortgage holders are encouraged to stick with their current lender, regardless of whether the rate offered by the lender is competitive or not.
“This is a consumer who is not borrowing any more money; their mortgage is simply up for renewal and they hope to have the ability to consider what their best options are,” Laird said. “There is no logic to requiring a new lender to apply a stress test when the incumbent lender is not required to do so.
“The existing lenders are using this hurdle to their advantage by not offering consumers the most competitive rates at renewal because they’re aware of their advantage in not having to apply the stress test.”