Bank Regulator Stands Firm on Mortgage Renewals: No Relief on Stress Test

Should Canada’s banking regulators abandon the mortgage stress test?

In 2016, the Canadian government introduced the mortgage stress test as a vital tool to curb risks associated with mortgage lending, especially when the Canadian real estate market experiences higher prices and lower interest rates. It was also amended in 2021 to require borrowers to prove they can maintain mortgage repayments that are 200 basis points above the contracted rate.

The mortgage stress test maintains two thresholds: a minimum qualifying rate (MQR) and an interest rate that is two percentage points higher than the borrower’s mortgage rate. As a result, today’s homebuyers could be experiencing rates between seven and nine per cent.

A chorus of housing and finance arguments argue that it is time to ditch or relax this measure as interest rates have risen to their highest levels since before the global financial crisis. Indeed, when the policy was introduced nearly a decade ago, mortgage rates were nearly half of today’s rates. Since July, the conventional five-year fixed-rate mortgage lending rate has been around six per cent.

Therefore, critics contend the Bank of Canada’s (BoC) tightening efforts have achieved some safeguards regulators have aimed to install throughout the nation’s housing sector, making the tool obsolete.

“I am all for building a buffer for people’s financial situation, but the stress test limits the amount people can borrow,” Matt Albinati, a mortgage broker with TMG The Mortgage Group, told Canadian Mortgage Trends. “You look back a year, the stress test was doing a pretty good job. This time—or near in the future—it might be a good time to take a closer look at it.”

But officials have been firm on the matter: no relief on the stress test is coming to the mortgage market.

No Relief on Stress Test Coming

The Office of the Superintendent of Financial Institutions (OSFI) says it will not be changing the mortgage stress or exempting some parties from the protective measure.

In response to the Canadian real estate industry’s wider fears about the possibility of new lending rules, the country’s chief bank regulator effectively shot down any expectation that the stress test is going away. In fact, industry experts make the case that the OSFI ostensibly doubled down on the method.

“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,” the OSFI said in an Oct. 16 report. “This is because the new lender must do its own due diligence as it will own the credit risk for an uninsured loan.”

In addition, the OSFI surprised mortgage brokers and lenders with this statement:

“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.”

For the most part, the mortgage sector had believed insured borrowers faced stress tests upon renewal if they transitioned to a new lender.

Meanwhile, Canada’s top banking regulator noted that exempting all mortgage renewals from the stress test “could cause lenders to compete for loans that do not meet” its expectations. At the same time, the OSFI conceded that it would assess data of uncompetitive rates for borrowers who cannot switch lenders and would “take action if warranted.”

And instead of dismantling the mortgage stress test, the OSFI is considering adding layers to the protective measure.

Regulators could mandate lenders to add more components to the stress test or insert a qualifying amortization period. This could be achieved by connecting the stress test to debt service metrics to determine the borrowers’ abilities to pay their loans and other expenses.

“We believe there is merit in lenders applying an explicit, qualifying amortization limit, and we will continue to evaluate this proposal,” the OSFI said.

Stress Test ‘Not Perfect’

At the September Scotiabank Financials Summit, OSFI Superintendent Peter Routledge conceded that the mortgage stress test “was not perfect.”

“Perhaps it is better to call it incomplete,” he said at the event. “We seek an integrated set of common-sense protections that work effectively both when interest rates are higher than normal, like today, and when interest rates are lower than normal, like during the COVID years.”

Industry leaders are holding out hope that maybe Routledge will heed the sector’s calls and make the necessary adjustments. Others think that the OSFI will only intensify the stress test, adding to borrowers’ growing costs.