OSFI looking at range of extra measures to mitigate rising lending risks
Mortgage lending risks are rising as rising interest rates make payments more onerous for households already struggling with heavy debt loads. Photo by Tyler Anderson/National Post Canada’s top bank regulator is seeking public input on whether it should beef up “stress tests” imposed on home buyers as rising interest rates make mortgages more onerous for households already struggling with heavy debt loads.
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The Office of the Superintendent of Financial Institutions (OSFI) is seeking input on whether to adopt a set of proposed complementary debt serviceability measures including interest rate affordability stress tests, loan-to-income and debt-to-income restrictions, and debt-service coverage restrictions.
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Since Guideline B-20, which includes the mortgage stress test, was introduced in 2012 and new thresholds added in 2018, “conditions in the Canadian residential mortgage market have shifted significantly,” OSFI said in a statement announcing the consultation.
“Mortgage lending risks, particularly related to debt serviceability, have increased considerably since the onset of the pandemic. These heightened near-term risks underscore the need to consider complementary measures to mitigate them.”
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Currently the mortgage stress test puts the minimum qualifying rate for an uninsured mortgage at the greater of the contract rate plus two per cent, or 5.25 per cent.
OSFI said it may choose to pursue one or more of the proposed measures to meet its prudential policy objectives, based on the feedback it receives as it considers revisions to Guideline B-20.
Submissions can be made until April 14.
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“Essentially, OSFI wants to skim another layer of the least-qualified borrowers out of the federally regulated mortgage market,” said mortgage analyst and strategist Rob McLister. “But how they’ll do that is not yet determined.”
McLister said he does not expect any changes to be made until around the third quarter of this year, which would give the housing market time “to digest high rates and rising unemployment.”
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Among the changes under consideration by OSFI are new interest rate stress tests. The regulator noted that floating-rate and short-term mortgages can carry “heightened” payment and renewal risks, so it could make sense to ratchet up the “affordability” test on these mortgages while making it easier to qualify for longer fixed terms that pose less risk.
OSFI is also considering whether lenders should apply the minimum qualifying rate rather than the actual interest rate to non-mortgage debt when calculating a borrower’s total debt servicing ability.
Another proposal on the table is new loan-to-income and debt-to-income restrictions, such as placing an overall limit on mortgage size based on the borrower’s income. The regulator could, for example, tell financial institutions they could devote no more than 25 per cent of their mortgage book to borrowers with loan-to-income ratios of 450 per cent or more, McLister said.
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The percentage of mortgage holders in this basket has risen to 26 per cent from 14 per cent, and he noted that the type of restrictions proposed by OSFI to deal with this trend were favoured by former Canada Mortgage and Housing Corp. chief executive Evan Siddall.
New debt ratio limits are also under consideration, which could include graduated or tiered gross and total debt service limits, an explicit amortization limit to be used in debt service limit calculations, and potential new capital restrictions for mortgages with high debt-service ratios. OSFI is also considering tweaking definitions and formulas for calculating gross and total debt service, perhaps bringing them in line with what is used for insured mortgages.
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Economists and bankers suggest mortgage defaults will become a big issue only if unemployment starts to rise sharply because Canadians have historically cut household spending in other areas in order to keep paying for their homes. However, if selling becomes the only option, the decline in home prices would complicate the picture for cash-strapped Canadians because mortgage debt could be close to or even outstrip the price the property is able to fetch.
McLister noted that average Canadian home prices fell 22.4 per cent over the past nine months as the Bank of Canada notched up the overnight interest rate from record low levels to where it now sits at 4.25 per cent.
OSFI said the tweaks it is considering to tap the brakes on the amount of debt home buyers can take on would limit potential lender losses and reduce the probability of borrower defaults “by making ongoing debt payments more manageable.”
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The regulator said the existing stress test gave homeowners a cushion when interest rates rose last year, but that built-in buffer has been reduced.
“Recent increases in mortgage interest rates have already eroded a significant portion of the debt service capacity provided for by the qualifying rate buffer, and debt service ratios are still increasing,” OSFI said.
“In a rising rate environment, the debt service burden rises as consumers pay more interest, which can have a meaningful impact, especially on households that are already financially stretched. In turn, this can lead to higher default rates.”
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