Penelope Graham, Director of Content
Updated on October 23, 2023
Canada’s mortgage stress test ( the threshold interest rate that borrowers must prove they can qualify at in order to get a mortgage) has been earmarked for some changes as of January 1, 2024.
Back in January 2023, OSFI (which stands for the Office of the Superintendent of Financial Institutions), opened up consultations for industry feedback on proposed changes to its Guideline B-20, the rules that regulate mortgage underwriting practices for Canada’s federally-regulated financial institutions. These potential tweaks included beefing up the stress test via tougher income requirements, which the regulator says is needed given rising rates and today’s overall riskier borrowing environment.
On October 16, OSFI released its response to that feedback – and while some proposals look to take effect in the new year, the regulator seems to be walking others back. Here’s a look at what may be coming down the pipe for borrowers.
(Most) borrowers will still be stress tested when switching at renewal
Perhaps one of the most controversial aspects of B-20 – and one that received plenty of media attention back when it was introduced in 2018 – is that borrowers looking to switch lenders upon renewal must be re-stress tested. This has been a point of contention within the mortgage industry as it makes for a less competitive marketplace, given borrowers are more likely to stick with their current lender rather than shop around at renewal (those sticking with their existing lender do not need to be re-tested).
However, pleas to exempt renewing borrowers from the stress test have fallen on deaf ears, as OSFI is doubling down on the need to stress test at renewal for those moving to a new lender.
“When a borrower opts to switch lenders, a new loan is created. We therefore expect that the loan be fully underwritten, including application of the MQR for uninsured mortgages to assess debt affordability,” states OSFI’s response summary. “This is because the new lender must do its own due diligence as it will own the credit risk for an uninsured loan.”
Currently, the stress test requires borrowers to prove they could carry their mortgage at a rate of 5.25% (known as the Mortgage Qualifying rate or MQR), or their contract rate plus 2% – whichever is higher. However, given that today’s lowest fixed and variable mortgage rates are all well above 3.25%, that 5.25% threshold has been effectively rendered obsolete.
Stress test exemption revealed for high-ratio borrowers at renewal
However, on the very next line, the regulator dropped a statement that surprised a number of industry members.
“Insured borrowers, however, are exempt from the re-application of the MQR when switching lenders at renewal. This is because the borrower’s credit risk has been transferred for the life of the loan to the mortgage insurer.”
This is news to brokers and lenders alike; until this statement was made, the industry has been very much under the impression that transactionally-insured borrowers are also to be stress tested upon renewal if moving to a new lender.
But it appears this exemption is indeed in practice: on Friday, October 20, 2023, Sagen and Canada Guaranty (two of Canada's largest default mortgage providers) issued a clarification confirming that high-ratio borrowers are not stress tested upon renewal upon switching, assuming they meet the following criteria:
- The loan amount does not increase
- The mortgage continues to amortize along the original amortization timeline approved by the original lender
"In response to industry inquiries following OSFI’s recent communication regarding the B-20 consultation, we are providing the following clarity," reads the statements from Sagen and Canada Guaranty:
Once a transactionally insured loan (borrower paid) is insured the eligibility criteria does not need to be re-assessed over the life of the insured loan, including if the loan is switched from one Approved Lender to another provided the loan amount is not increased and continues to be amortized in accordance with the amortization period approved by the insurer. It is expected that an Approved Lender complete due diligence reviews when accepting the transfer of an insured loan as in so doing they assume all responsibilities of the original Approved Lender inclusive of underwriting these files consistent with their own Residential Mortgage Underwriting Policy (RMUP)."
"In all cases, once an applicable loan is insured, eligibility criteria does not need to be re-assessed at the time of renewal over the life of the insured loan (e.g. a lender can renew the loan without “re-qualifying” the loan)."
OSFI won’t toughen TDS and GDS ratios
The regulator has confirmed that it will not create tougher requirements for borrowers’ debt service ratios, which was part of a larger proposal to limit the number of loans lenders can provide to higher-risk borrowers.
Currently, lenders use two main calculations when qualifying a borrower for a mortgage: the Gross Debt Service (GDS) ratio and the Total Debt Service (TDS) ratio, which cannot exceed a maximum of 39 and 44%, respectively.
Also read: Debt service ratios – what you need to know
“After careful consideration of stakeholder feedback, we agree that regulatory limits on debt service coverage should not be pursued,” states OSFI. “While such limits could result in greater consistency, they would remove too much risk-based decision-making and risk ownership from lenders. While clear limits apply to insured mortgages, under law, they generally serve other public policy objectives beyond prudential soundness and financial stability. A strengthened principles-based expectation could therefore be more suitable.”
New loan-to-income (LTI) measures may be introduced
However, borrowers may need to brace for new loan-to-income requirements, which could limit the amount of mortgage they qualify for based on how much money they make, regardless of the size of their down payment. More specifically, affected borrowers would be capped at a loan amount no larger than 450% of their income. While OSFI acknowledges that the industry feedback has been “generally not supportive”, they appear to be making an impassioned argument for the new criteria as a stopguard to prevent lenders from taking on too many highly-indebted borrowers in their portfolios.
“We agree that debt service ratios (i.e., GDS and TDS), under certain conditions, can produce similar outcomes to LTI/DTI although they are focused on debt affordability as opposed to limiting exposure to high indebtedness. We also acknowledge that most lenders do not use LTI/DTI measures in underwriting,” they write.
“We appreciated lenders’ analysis on predictors of default and agree that credit score and other factors can be better predictors than high LTI or DTI. That said, high household indebtedness is still relevant to credit risk, the safety and soundness of FRFIs, and the overall stability of the financial system. In a benign, low interest rate environment, higher household debt levels are easier to service, and this can mask the true risk to borrowers and lenders until conditions change. Mortgage and other household indebtedness continued to build up in recent years despite existing measures.”
Final changes to B-20 will be confirmed in January
Keep in mind, the changes outlined above are not necessarily set in stone, and only reflect OSFI’s response to feedback to the proposed measures. We’ll report back in January once the regulator officially puts the new measures into place, confirming just how they’ll impact borrowers in the new year.