Canada’s Bank Regulator Wants Tighter Rules To Address Real Estate Risks

Canadian homebuyers might face stronger regulations around mortgage borrowing soon. Office of the Superintendent of Financial Institutions (OSFI), Canada’s bank regulator, is soliciting feedback on a series of new rules to reduce leverage and mitigate risk. Now that risk tools like the stress test have proved why they’re important, they’re seeking to address any gaps that may have popped up. Here’s what they’re looking at. 

Canadian Mortgage Borrowers Might See A Loan To Income Ratio Limit 

Households may soon face loan-to-income (LTI) and debt-to-income restrictions that restrict total leverage. The LTI ratio is the measure of household debt as a share of income. For example, a 200% LTI ratio means a borrower has an outstanding loan that’s 2x their income. When a mortgage has a LTI ratio of 450% (4.5x income), the borrower is considered overleveraged, or highly indebted. Breaching this threshold means a borrower is vulnerable to shock. 

Currently, there are no restrictions on the amount of loans that can be made at this level. An analysis by OSFI shows nearly 1 in 3 mortgage originations in Q3 2022 are to overleveraged borrowers. It’s down from 40%, but since the start of the pandemic highly leveraged borrowers have become a bigger part of the market. 

OSFI is considering changing this by adopting a “high LTI threshold” of 4.5x for mortgages. This wouldn’t eliminate these borrowers, since lenders see less risk for certain high income, solid credit buyers. It would instead limit the share of these mortgages to 25% of lender originations. It’s higher than the pre-pandemic average of 23.8% of new mortgage loans, but still means 8.7% of recent loans would not have been as large as they were in the last reported quarter.  

The tentative impact would be a reduction in leverage, improving the ability to absorb shock. It would also lower leverage, reducing the maximum the market can absorb. This is probably a good thing, since highly indebted speculators have become a significant part of the market, outbidding end users. 

New Zealand recently implemented a similar measure that’s had a significant impact. Though not nearly as big as higher interest rates. 

Reducing Overleveraged Mortgage Borrowers With Debt Service Coverage Rules

OSFI is also considering debt service coverage restrictions, which would limit obligations to a share of income. Federally regulated lenders already deal with these to some extent, at least when it comes to insured mortgages. 

Insured borrowers are tested to ensure that their housing payments don’t exceed 39% of their income with a gross debt service ratio (GDS). Housing payments and all other debt, such as auto and student loans, are restricted to 44% of income using a debt service ratio (DSR). 

“Beyond those requirements, B-20 does not articulate limits on GDS and TDS for uninsured mortgages and generally permits FRFIs to establish debt serviceability metrics under their RMUPs that facilitate an accurate assessment of a borrower’s capacity to service the loan,” reads the industry consultation documents.  

More bluntly, federal lenders aren’t officially restricted by GDS or TDS for uninsured mortgages. They’re expected to have risk mitigation planning, which means not make dumb loans. However, there’s no standard across federal lenders, or anything written in stone.  

OSFI is considering changing that by potentially applying similar rules to lenders. It might be explicitly applied to the borrower, or applied across the lender portfolio. They also would like to limit excessive amortization terms to help achieve this. Ultimately, the stated goal is another cap on leverage in case a borrower escapes the others, though not necessarily an additional impact. 

Canadians Might See A Revamped Stress Test, and It Might Be Applied To Consumer Loans Like Auto

Interest rate affordability stress testing is a revamp of the “mortgage stress test” you’re familiar with. Currently mortgage borrowers should be tested against a minimum qualifying rate (MQR), which determines how much leverage they can have. However, this one-size-fits-all method saw people turn to variable rate mortgages to qualify at a lower rate. That didn’t work out so well, with many variable borrowers now sitting on interest rates that exceed the stress test rate.  

OSFI is considering eliminating this risk by applying different MQRs based on product risk characteristics. For example, a variable rate mortgage just demonstrated higher risk than its fixed-rate alternatives. Since longer fixed terms have lower risk of payment shocks, they would have a lower qualifying rate. 

The regulator is also considering testing for consumer debt payments, which would be interesting. Currently testing the stress test rate to the TDS ratio is only expected, but they suggest it might need to be explicitly stated. 

Retail lending might also soon find itself with a stress test. The vaguely worded consideration mentions the potential to stress test non-mortgage retail lending. Non-mortgage retail lending would include things like auto loans, which have recently been climbing as prices approach astronomical limits. Not a terrible idea. 

OSFI’s feedback period is often dismissed as just consideration, but they aren’t just spitball ideas. These are solutions to address issues that they may not have totally communicated to the public. The consultations are more like—why shouldn’t we do this? It’s hard to explain why after excessive leverage began to dominate housing. 

In addition, we’re expected to get an update on further underwriting policy. The regulator has been discussing combined-loan plans (CLPs) repeatedly, explaining households are perpetually carrying debt and increasing their risk of vulnerability during economic shock. They warned it would need to occur in the event of a steep drop in home prices or job losses, and the first of those two has arrived.

13 Comments

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  • george 2 weeks ago

    The sleep of reason produces monsters. These rules should have been implemented years and years ago. But no, let’s be greedy.

    Avrg Vancouver household income is almost $100k as per google. Which means the maximum mortgage amount banks might give you is below $450k….Good luck finding anything at that price unless you have a large downpayment.

  • Ray 2 weeks ago

    Everything in their power to collapse the housing market.
    They really want the prices to come down.

    • Miff Tacklem 1 week ago

      I hope so. For the sake of all future generations of Canadians, the price needs to crash. Young people won’t stay here if the Canadian lifestyle includes rental serfdom with the bonus of 6 month long winters.

  • Charlie 2 weeks ago

    You can’t be too cynical about how the RE market and debt servicing has been managed in Canada.

    This will almost certainly be another headwind for an already collapsing RE market (good!). What is worrying is: why now and who does this serve? These measures should have been done not 5 years ago but 20. Who does this affect? Certainly not those with piles of capital or the money launderers. So, let’s help the market collapse, restrict residents from buying in that collapsing market, and … voila! More rental serfs.

  • Freddy 2 weeks ago

    These all sounds like great ideas to stop people from borrowing their brains out. The problem is, OSFI usually gives a 6 month warning before implementation of new rules.

    People end up borrowing their brains out ahead of the new rules being implemented, trying to front run the new rules.

    Kind of ironic but the new rules will usually cause a frenzy of borrowing activity.

  • Mike 1 week ago

    Bang on Freddy OSFI wants to push buyers forward.Bet new rules will be in effect end of April.😤😤😤

  • Paul 1 week ago

    I am a mtg broker in bc. Have been for 11 years. I am very successful, have done over $1 billion in lending over that period of time. I have a degree in economics.

    LTI of 4.5 would DECIMATE real estate in BC and ONT. As in; sell all your property now or go bankrupt.

    • Timmie O'Toole 1 week ago

      technically they’re limiting LTIs in excess of 4.5% to 25% of originations, so decimate might be an exaggeration. What share of originations require LTI > 4.5 at your lender?

  • Concerned Homeowner 1 week ago

    This is disgusting… we already have insanely stringent stress testing to ensure only over qualified buyers are entering the market. Hence the reason VERY few people can qualify for a mortgage right now for purchase or refi. Stress test being at 8%+ for a AAA bank mortgage on top of the TDSR restrictions. These regulators already have the market in a choke hold, this is a targeted nationwide collapse that is going to cost current mortgaged homeowners dearly… all for what? so the people who don’t want to do anything more than work a regular 9-5 and whine about the housing market can afford to purchase a house? These heavy handed moves are doing far more harm than good to the people that worked hard to get to where they are today.

  • Concerned Homeowner 1 week ago

    You’re talking 225K income for a $1M home (in the Greater Toronto Area in ON that’s under the average home price)
    225K is still 4.5x. I can tell you for sure the average homeowner or couple is not making 225K per year let alone more. “Median income levels In 2021, the median total household income in Toronto was $84,000” source – Toronto.ca. I’d say “Decimate” is the perfect word to use, every homeowner with a mortgage should be terrified and ready to fight to keep what they worked for.

    • Julian 5 days ago

      Rather, prices must fall to a normal level relative to average wages so that homes become affordable and no one has to fight for their right to own property. And why should the lenders be punished so that the beneficiaries can sleep peacefully paying off their mortgages?!

  • Julian 5 days ago

    every homeowner with a mortgage should be terrified and ready to fight to keep what they worked for.
    Rather, prices must fall to a normal level relative to average wages so that homes become affordable and no one has to fight for their right to own property. And why should the lenders be punished so that the beneficiaries can sleep peacefully paying off their mortgages?!

  • Julian 5 days ago

    Rather, prices must fall to a normal level relative to average wages so that homes become affordable and no one has to fight for their right to own property. And why should the lenders be punished so that the beneficiaries can sleep peacefully paying off their mortgages?!

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