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Canada’s top banking regulator has published the final version of its new mortgage rules, which include a requirement to “stress test” borrowers with uninsured loans to ensure they could withstand higher interest rates.
The Office of the Superintendent of Financial Institutions (OSFI) released new guidelines for the mortgage industry on Tuesday. The regulator floated a similar version of these rules earlier this summer in draft form, but Tuesday’s release makes them official as of Jan. 1.
Among the major new rules is a requirement to stress test uninsured borrowers. Previously, only insured borrowers had to undergo such a test.
By law, borrowers with a down payment of under 20 per cent for a home must purchase mortgage insurance. Borrowers pay an insurance premium, but the beneficiary is actually the lender, because the insurance protects the loan giver in the event the borrower defaults on the loan.
And the insurance premiums can easily be into the thousands of dollars, on top of the cost of a home, ranging from 0.6 to 4.5 per cent of the mortgage, depending on the size of the down payment and the price of the property.
According to the Bank of Canada, the big banks currently have an average five-year posted mortgage rate of 4.89 per cent. But it’s not difficult to find a lower rate by shopping around. (Rate comparison website ratesupermarket.ca calculates that many lenders are offering five-year mortgages below three per cent, as does rival RateSpy.com and many others.)
The stress test is designed to simulate a borrower’s financial situation by assuming they would have to pay back the loan at the posted average — not whatever deal they were able to negotiate. So under OSFI’s new rules, borrowers would be stress tested at either the five-year average posted rate, or two per cent higher than their actual mortgage rate — whichever one is higher.
Notably, the new stress test rules won’t apply to mortgage renewals as long as they are with the borrower’s existing lender.
The regulator published a draft of its new rules over the summer, before consulting with stakeholders about any changes that need to be made. The regulator said it received more than 200 submissions from people in the industry and members of the public about the rules as they were proposed in July.
“These revisions reinforce a strong and prudent regulatory regime for residential mortgage underwriting in Canada,” said Jeremy Rudin, OSFI’s superintendent.
TD Bank economist Brian DePratto agrees with that assessment, noting “on balance, these changes should help enhance the resilience of the Canadian banking system in a rising interest rate environment.”
But that’s not to suggest there won’t be pain to be had because of them. DePratto estimates that expanding the stress test to all buyers will depress demand for housing by about five or 10 per cent, and there may be a mini-rush to get in before the new rules come in in January.
He believes the housing market’s reaction to the last stress test rules in 2016 are a good example of why the regulator felt compelled to act again: As of August, insured mortgages were down 4.5 per cent in the 12 months since they were subject to a stress test.
Uninsured mortgages, meanwhile, grew 17.3 per cent — which suggests homeowners were doing anything they could to get their down payments above the 20 per cent threshold, and away from being locked out of an insured mortgage from failing a stress test.
“Estimates peg the uninsured market at roughly 80 per cent of activity recently, so this measure will bite, arguably more than past changes in the priciest markets,” Bank of Montreal economist Doug Porter said.
“These changes in mortgage rules represent a further tightening of the screws for the housing market.”
“In the mortgage world, a lot of people are talking about how it’s too stringent and the government is tightening up far too much, considering what the delinquencies are in this country for mortgages,” she said in an interview.
In addition to the stress test, the new rules would require lenders to have more scrutiny around the loan-to-value ratio of the loans they give out, to ensure they are not giving out mortgages that are too large compared to the underlying value of the home.
There’s also new limitations on so-called co-lending or bundled mortgages that aim to ensure lenders don’t flout rules designed to limit how much they can lend.