Canada

Canada’s Riskiest Real Estate Buyers Are Disappearing After Mortgage Stress Tests

Think stress tests are a bad thing? You clearly have no idea who it’s stopping from buying. Bank of Canada (BoC) numbers show stress tests may have stopped a large number of borrowers from getting in over their head. Almost immediately after stress tests were implemented in both high and low ratio mortgages, the market saw a dramatic decline of borrowers buying “too much” house.

I Totally Know What A Loan-To-Income Ratio Is, But Just Explain It Again…

Have you ever heard that a home should be 2-3 times your income? Of course not, most of you are Canadian. Financial experts suggest a mortgage about 2x your income, and no more 3x. That number is called a loan-to-income (LTI) ratio, and is the size of a loan compared to the income behind it.

In Canada, the LTI rule was twisted by the mortgage industry into your payments should be a third of your income. The switch allowed people to accept increasing debt loads, as interest rates fell. That idea wouldn’t be terrible in a country with fixed rates for the whole duration of the mortgage – like the US. However, it can become a bit of a problem when interest rates are on the rise, and you’re likely to renew at a higher rate.

Regulators haven’t forgotten the 4.5x max rule, and have been watching households with an LTI over 450%. These borrowers are called “highly indebted” at the BoC, and are people that bought “too much house.” That is, they’re taking out a loan disproportionate to the income they make. Rates are just off of record lows, but that increases the odds of experiencing higher debt servicing costs in the not so distant future. Households with high LTIs will have the hardest time adapting to higher payments. That’s precisely why most mortgages in Canada are now stress tested, to eliminate highly indebted borrowers.

Total Borrowers With Loan-To-Income Ratios Are Down Over 11%

Since stress testing was implemented, highly indebted borrowers have been disappearing. Only 16.58% of mortgages went to this segment of borrower, down 11.09% from the previous year. Peak borrowing in this segment occurred in Q3 2016, and we’re now 12.13% lower from that number. To see how stress testing saved many households from financial suicide, let’s break it down by implementation.

Canadian Mortgages To Households w/LTIs > 450%

The percent of mortgage originations to households with loan-to-income ratios higher than 450%.

Source: Bank of Canada. Better Dwelling.

High-Ratio Mortgages To Highly Indebted Borrowers Are Down Over 54%

High-ratio mortgages, those with a downpayment of less than 20%, were the first to get hit with a stress test. These mortgages are subject to government-backed insurance, and therefore experience stronger regulations. When highly indebted borrowers rushed to these mortgages while prices soared, the Crown corp incharge took action. They made borrowers undergo a stress test, before their loans could be insured. The test became mandatory in Q4 of 2016.

Since stress testing high-ratio borrowers became mandatory, highly indebted borrowers disappeared. Only 9.35% of high-ratio mortgages went to households with a LTI of 450%, down 28.57% from the same quarter last year. Since stress testing was implemented, highly indebted borrowers declined by 54.98%. Maybe it’s a coincidence, and high-ratio borrowers became conservative borrowers at the same time. Now where’s that darn eye roll emoji?

Canadian High-Ratio Mortgages To Households w/LTIs > 450%

The percent of high-ratio mortgage originations to households with loan-to-income ratios higher than 450%.

Source: Bank of Canada. Better Dwelling.

Highly Indebted Borrowers Taking Out Low-Ratio Mortgages Is Down Over 9%

Low-ratio mortgages, when a buyer puts more than 20% down, have a different set of rules. In theory, these borrowers are lower in risk, but many were people borrowing down payments to sidestep insured stress tests. The Office of the Superintendent of Financial Institutions (OSFI) implemented stress testing on January 1, 2018,  to be safe. Much like high-ratio mortgages, the ratio of highly indebted low-ratio borrowers dramatically declined.

The Canadian real estate market started to see a decline of highly-indebted low-ratio borrowers almost immediately. The ratio at the end of Q1 2018 fell to 17.59%, a 9.6% decline compared to one year ago. Since implementation the quarter before, the ratio made 9.32% of the decline. It’s clear that the stress test is saving borrowers from taking out too much mortgage in this case as well.

Canadian Low-Ratio Mortgages To Households w/LTIs > 450%

The percent of low-ratio mortgage originations to households with loan-to-income ratios higher than 450%.

Source: Bank of Canada. Better Dwelling.

Stress tests are being demonized by the industry, and even some politicians. Many claim it’s the reason behind lower price growth, but it was unsustainable growth to begin with. Stress tests reduce the maximum mortgage size, and prepare buyers for higher rates. The only buyers impacted by these test, are ones that would have been highly indebted. The more of these buyers that pile into the market, the higher risk the market becomes as rates rise. The industry should be celebrating that loan quality is improving, instead of complaining that they can’t get a family into a loan that’s questionably large.

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52 Comments

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  • Reply
    CS 2 months ago

    People should be happy that risks are decreasing, but they wont be.

    And when the market completely hits the skids, everyone will blame the government messing with the “free market”, and not idiots buying homes they could never afford.

  • Reply
    Mac 2 months ago

    Thanks for this. I just assume any politician opposed to the stress test is a shill for the real estate industry. If Canadians have guarantee the bonds the banks use to fund mortgages, banks shouldn’t be able to make risky loans and transfer the risk to taxpayers, but keep the profits.

  • Reply
    Po 2 months ago

    But how many regular households are forced to use private lenders, and pay rates 3x times what they would without a stress test? These tests also kill affordability, by forcing borrowers to adopt predatory loans.

    • Reply
      Michael 2 months ago

      None. It’s literally designed to only prevent people from borrowing too much. If you’re going to a private lender and the payments are lower, double check that you’re not on an interest only payment plan.

    • Reply
      John 2 months ago

      Who is forcing them?

      The family is making a conscious effort to skirt the safeguards the government is trying to provide them.

      It’s like telling your child not to do something, so they stare at you as they do it anyway.

      I dont wish sorrow on people, but seriously, if you’re pushing ahead anyway you can piss right off when it goes sideways.

      • Reply
        Bluetheimpala 2 months ago

        Ding ding ding…spot on …my 3 year old would eat cheetos all day. He gets angry when I catch him with the bag scarfing it down. He puked once but went right back. Unfortunately we all became 3 year olds and now we’re made because the parents had to step in…boohoo…BD4L.

    • Reply
      Bluetheimpala 2 months ago

      ‘Regular’ people don’t get caught up in FOMO and make bad financial decisions because their buddy at work did. If you’re referring to ‘FOMO’ people then a lot will continue to screw themselves over and then feel the pain when reality comes crashing down with each and every rate hike.

    • Reply
      JTEpic 2 months ago

      Forced? Who is holding a gun to people’s heads to BUY a SFD they can’t afford on credit?

      Again, it’s this mentality that everyone must buy the house they want, now, with “money” that is not theirs. Need affordable housing? Move.

      Overpaying for a mortgage is just dumb entitlement.

  • Reply
    Bluetheimpala 2 months ago

    Damn, did I leave the door open when I locked up last night…see the regular partisan crap that bubbles to the top when times get tough. Guys like Ivan and his ilk have such a myopic view of life and society; easily blaming others and the powers that be when in reality we ate too much, puked and then are the puke for a good 2-5 years. ‘Good canadians’ have been brutalized by the government and regulation…blah blah blah. Rates will continue to increase and more controls on foreign speculation will be put in place. We’ll be in a recession in 2019 if not before. If you honestly think the housing in Canada is sustainable you’re a fucking moron and the reckoning will hit you and your flock far worse than though who live in the light. Winter is here. Bundle up muffins. BD4L.

  • Reply
    Spectator101 2 months ago

    *Stephen, can I get some popcorn? Thank you.

  • Reply
    @xelan_gta 2 months ago

    First of all, I 100% support stress test so whatever I say below doesn’t change that fact.

    “The Canadian real estate market started to see a decline of highly-indebted low-ratio borrowers almost immediately. The ratio at the end of Q1 2018 fell to 17.59%”
    Those are great news, but in order to have full picture we need to compare those numbers to total mortgage originations, private mortgage lending originations and other credit products changes.

    If private lending is growing at the same time as High LTV originations are declining at big banks that is definitely bad for homebuyers and overall financial stability.

    This article may explain BoCs approach as well if they are mostly looking at LTV numbers and then claim that credit quality is improving.
    B20 is good and it’s doing its job removing risk from big banks balance sheets, no doubt about it. It’s just my view is not so rosy and I can see new risks created as a result of B20 as well.

    • Reply
      Rr 2 months ago

      Sometimes you just cannot save people from themselves or their friendly, RE agent who also happens to be a mortgage broker, who can arrange an alternate lender for a year, but next year when the house goes up by 20%, you can get a mortgate at under3% at a regular lender. And you will be able to use your rental income from the illegal besement apartment to qualify or some not so real income documents if you pay a little bit of money…….

  • Reply
    Ham 2 months ago

    Wow, clearly this article describing prudence measures irked some/all of the following groups:

    * Bag holder speculators who lost hundreds of thousands over the last year
    * Mortgage brokers
    * Realestate agents
    * Developers

  • Reply
    Mark Baum 2 months ago

    Ivan I’m with you.

    1 change, remove government intervention: Take away CMHC mortgage insurance for new buyers. Force private industry to take on the risk/insure the mortgages.

    Remove OFSI stress test (are you assuming private industry won’t implement their own, lol), foreign buyer tax, etc. It’s just 1 change – would that make you happy?

    Market would fall apart extremely quickly BTW.

    • Reply
      Mark Baum 2 months ago

      To be clear my point is, reverse the numerous regulations that are irking you/added last year, and make 1 change only which would be removing CMHC mortgage insurance for new buyers. Private industry (ie. Genworth, banks, etc) would then insure new mortgages solely from that point on and sell at premiums/risk levels that they see fit.

  • Reply
    Adam 2 months ago

    Prices have dropped slightly but the major issue in Toronto is that sellers are still in denial that 2016/7 is gone. They want what the neighbor got and they arent going to get it.

    My prediction is prices fall 10-15% by the end of the year with 2019 offering major uncertainty due to rising rates coinciding with renewals.

    I am a private lender*

    • Reply
      @xelan_gta 2 months ago

      If you are indeed a private lender do you understand that your prediction will cause you problems?
      As far as I know private lenders provide short terms loans(1-2y) and then borrowers refinance.
      If borrowers came to you that means their finances are not great or shady.
      When prices fall 10-15% how do you think they will be able to refinance?

      • Reply
        Adam 2 months ago

        If they default they lose the property. It’s not the end of the world.
        I didn’t say prices will never rebound. I believe we (real estate industry) are in need and deserving of some short term pain. 2016 will go down as a once in 50 year episode whereby the masses were blinded by greed and desperation.
        Long term (10-20 years) the money lending business is the way to to.

        • Reply
          @xelan_gta 2 months ago

          Be careful, because GTA market is overvalued by at least 30%. Nobody knows when it corrects and how deep it will be but it would be smart to calculate risks for that scenario as well. As far as I understand if borrower defaults you will only receive money in case there are leftovers after bank’s foreclosure.
          Good luck with your business.

        • Reply
          RM 2 months ago

          Adam, I am completely bearish on real estate but I greatly appreciate hearing sensible comments from those who benefit from a bullish market. I am actually a home owner with no debt, so my views technically affect me negatively, but I don’t want to be blinded by that. If we could all just agree that we got a little greedy and pushed things to unhealthy levels we would better off, at least in the long run.

  • Reply
    @xelan_gta 2 months ago

    Hot discussion today, I just want to clarify for all bulls/neutrals, especially LL and Ivan

    Should government intervene when RE prices grow 30% in 3 months when it’s clear bubble? Most likely. Seems like everyone pretty much agree here.

    If you are OK with government trying to slow down the market and engineer “Soft landing” you should understand one thing: Bubbles never end up in “Soft Landing”, they only end up in “Hard landing”. Study history of bubbles and you will understand why it’s happening.

    So it’s pretty much doesn’t matter what government is trying to do now as long as they try to slow down the market it will eventually crash it and it’s not their fault. They are doing great job at protecting as much important stuff as they can right now.

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