The mortgage stress test serves the crucial purpose of ensuring borrowers can comfortably afford their mortgage payments.
Its primary goal is to safeguard Canadians from undertaking excessive debt when purchasing a home or refinancing their existing mortgage. In January 2023, the Office of the Superintendent of Financial Institutions (OSFI) desired industry input on potential adjustments to its Guideline B-20, the regulations governing mortgage underwriting practices for federally regulated financial institutions in Canada. Among these proposed changes was a strengthening of the stress test through more rigid income requirements. OSFI believed these measures were necessary due to the increasing interest rates and the elevated risk associated with borrowing in today’s financial landscape. On October 16, OSFI released its response to the feedback received during the consultation process. While some of the proposed changes are set to take effect in the new year, the regulator has decided to reconsider and revise a few things. Here’s an overview of what borrowers can expect in the near future.
Borrowers will continue to undergo a stress test when switching lenders upon renewal
The stress test requirement for most borrowers switching lenders upon renewal remains a contentious issue, garnering significant media attention since its introduction in 2016. Under these rules, borrowers who wish to change lenders during their mortgage renewal are subjected to a re-stress test. Making borrowers more likely to stay with their current lender rather than explore other options. Despite industry calls to exempt renewing borrowers from this stress test, OSFI remains resolute, emphasizing the importance of stress testing during lender transitions. OSFI’s response summary underscores this position: When a borrower chooses to switch lenders, a new loan is created. As a result, we expect a thorough underwriting process, including the application of the Mortgage Qualifying Rate (MQR) for uninsured mortgages to evaluate debt affordability. This is necessary because the new lender assumes credit risk for an uninsured loan. Currently, the stress test mandates that borrowers demonstrate their ability to manage their mortgage at a rate of 5.25% (Mortgage Qualifying rate or MQR) or their contract rate plus 2%, whichever is higher.
Stress Test Exemption Unveiled for High-Ratio Borrowers at Renewal
In a surprising turn of events, the regulator has clarified a significant exemption for insured borrowers regarding the stress test during lender transitions at renewal. This exemption pertains to borrowers whose loans are insured, and it means they are not required to undergo the Mortgage Qualifying Rate (MQR) re-application when switching lenders at renewal. The reason behind this exemption is that the borrower’s credit risk is already transferred to the mortgage insurer for the entire loan duration. This announcement has become a revelation to many in the industry, as it had been widely believed that transactionally insured borrowers would still be subjected to stress testing upon renewal if they decided to change lenders. The exemption is indeed in practice, and two major default mortgage providers in Canada, Sagen and Canada Guaranty, confirmed this on October 20, 2023. High-ratio borrowers can benefit from this exemption provided they meet the following conditions:
- The loan amount remains the same.
- The mortgage continues to be paid off according to the initially approved amortization schedule set by the initial lender.
Both companies issued statements to clarify this matter, emphasizing that once a transactionally insured loan is insured, there is no need for re-assessment of eligibility criteria throughout the life of the insured loan. In summary, once a loan is insured, there is no requirement for re-assessment of eligibility criteria at the time of renewal throughout the life of the insured loan. Lenders can renew the loan without the need for re-qualification.
Prepare for Potential New Loan-to-Income (LTI) Rules
Borrowers should be ready for potential changes in loan-to-income (LTI) requirements, which could impact how much mortgage they qualify for based on their income, regardless of their down payment size. Specifically, these changes may limit borrowers to a loan amount no greater than 450% of their income. Although the industry feedback has generally not favoured these new measures, OSFI is making a solid case for them to prevent lenders from taking on too many highly indebted borrowers. OSFI acknowledges that debt service ratios (such as GDS and TDS) can achieve similar results to loan-to-income & debt-to-income (LTI/DTI) measures under certain conditions. Still, these ratios focus on debt affordability rather than limiting exposure to high indebtedness. They also recognize that most lenders do not currently use LTI/DTI measures in their underwriting. While lenders have provided analysis on predictors of default and suggested that credit scores and other factors can be better indicators than high LTI or DTI, OSFI emphasizes that high household indebtedness remains relevant to credit risk, the safety and soundness of financial institutions, and the overall stability of the financial system. In a low-interest-rate environment, high household debt levels might seem manageable, but they can pose risks to borrowers and lenders when conditions change. Despite existing measures, mortgage and household indebtedness have continued to rise in recent years.