Canada

Canadian Bank Regulator Readies To Reverse Extra Pandemic Mortgage Leverage

Canadian real estate markets may have got the first big cooling measure today. The Office of the Superintendent of Financial Institutions (OSFI) announced they are moving to tighten uninsured mortgage leverage. The organization that regulates Canada’s banks, eased the mortgage stress test last year. Now that it’s clear mortgages don’t need stimulus, they’re looking to reverse the test to pre-pandemic levels. The regulators giveth, and the regulators taketh away. 

OSFI Proposes To Reverse Extra Pandemic Mortgage Leverage 

OSFI proposed an increase to the benchmark rate used for the mortgage stress tests. Uninsured mortgages would see the current benchmark rise from 4.79% to 5.25%, setting a new floor for leverage. If the move successfully proceeds, it would reduce the current max mortgage drop by 5%. Not exactly earth-shattering, but it rolls people back to pre-pandemic levels.

What The Heck Is A Stress Test?

If that sounded totally foreign to you, let’s unpack the OSFI mortgage stress test. The test applies to uninsured mortgages at banks, and checks buyers against a higher qualifying rate. It’s a basic form of risk management to assess a borrower’s ability. In non-bankster, this does 3 big things to help the financial system:

  1. Lowers maximum mortgage leverage. This helps to prevent people from getting up to their neck in debt. When that happens, they become a higher default risk. 
  2. Qualifies your ability to pay higher mortgage rates if credit conditions improve. When mortgage rates are near record lows, they likely won’t stay there. If you are tested at a higher mortgage rate, you’ll know you can handle any future increases. 
  3. Protects the economy from over-allocation in housing. When interest rates are low, housing becomes attractive. Sometimes too attractive. A stress test allows cheap credit while preventing people from over-allocating. 

How Is The Canadian Mortgage Stress Test Done?

Lenders test you against a contract or the benchmark rate — whichever is higher. The contract rate is the rate you’ll pay, plus 2 points to determine how you can handle a hike. The benchmark is the BoC 5-year fixed, which is currently 4.79%. Whichever is higher, is the number you are tested with. 

Just to make it crystal clear, let’s go through a quick example. We’ll assume you have a household income of $100,000, and find a 5 year fixed rate mortgage at 2%, with a 25-year amortization. You’re not just good at your job, you’re also a great mortgage hunter. 

Using no stress test, you would be able to borrow a maximum of $708,500, less servicing costs like property taxes. If you were stress-tested with 2 points added, that drops about 20% lower. 

Except, in this case, 2 + 2 is less than 4.79%, so you’ll need to use the benchmark rate. Using the benchmark, the maximum mortgage is $526,600, before servicing costs. It’s about 4% lower than if the contract rate was used to determine the max. 

Markets Change Faster Than People Expect

The jump from 2% to 4% might sound like a ridiculously fast climb, but a lot can happen in 5 years. From 2016 to 2019, Ratehub historical data shows the 5-year fixed-rate jumped 55%. Other risk factors include a deterioration in quality. Just because you qualified with the best rates, doesn’t mean you’ll renew with it. In a worst-case scenario, you most likely handle payments with ease. In a best-case scenario, you have more money to diversify your investments and spend on life. 

The measures are currently proposed, so they aren’t final until the consultation. It’s hard to not see them going through since they’re just rolling back pandemic ease. This also comes after OSFI noted mortgage borrowers were over-leveraging once again. As well as banks asking the government to do something about this mortgage binge

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17 Comments

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  • Reply
    Patrick 2 days ago

    Remember when everyone said the stress test was nothing. Detached homes will got forever!

    [West Vancouver detached home prices trade 30% lower]

  • Reply
    Vincent Fornelli 2 days ago

    5% drop in buying power is nothing. Barely takes the market back two months.

    • Reply
      Mortgage Guy 2 days ago

      Actually a huge issue. This impact is on the marginal buyer, that’s pushing their leverage to the extreme.

      You remove 5% from them, and that delays buyers. Delay buyers, and the surge of sales that have been killing the soaring inventory starts to balance.

    • Reply
      Sam 2 days ago

      It’s psychological. Who knows what will trigger a mass reverse of this FOMO-mania.

  • Reply
    Mortgage Guy 2 days ago

    If OSFI is changing something, it’s because they already had this discussion with the banks.

    The financial industry isn’t known for springing something up. This is probably a coordinated critique in response to international criticism.

    • Reply
      Paul 2 days ago

      Or just national criticism. I guess you think they don’t listen to the narrative about an entire generation being priced out of the Canadian dream….

      • Reply
        Itchy Bear 2 days ago

        Think boomers still agree the generation just avocado toasted out of the Canadian dream.
        This very much seems to be the least they can do.

  • Reply
    SH 2 days ago

    Look, as long as criminals from overseas continue to have free reign to purchase Canadian homes sight unseen with laundered cash, not much will change.

    It’s time the government put CANADIANS first (I know, so radical) and ban foreign buying of Canadian homes.

    Canadian homes for Canadians. Period.

  • Reply
    Holton 2 days ago

    That stress test does not apply to B lenders. With all the printed money flowing around there is no way prices will drop. They should have let the price drop during the pandemic. Its too late now, the whole world is on its way to recovery, we can’t let prices crash now or we are screwed.

  • Reply
    youngjok 2 days ago

    What a joke. This won’t do squat to the market. Besides the damage is already done. We have approximately 4-5 years of price increases build into 1 year now.
    They should have done the following:
    -Scale back debt ratios to 30 GDS and 40 TDS with no exceptions.
    -Cap amortizations to 25 years
    -Cap refinances to 65% LTV for rental properties and 75% for owner occupied.

    Because of their lack of courage to do the right thing to reign in this housing market prices will continue to soar and youngsters will continue to get screwed. We need lower prices that are affordable and not more debt.

  • Reply
    IthoughtWeWereSmarter 1 day ago

    Left this on Turner Nation today, but thought I should share with as many as possible…..

    We bought our 1st GTA house (townhouse condo) in late ’91 and we sold it in mid ’99 for $5k less than what we paid for it!!! No exaggeration!
    We watched as places the same as ours started dropping 20-25% for the first 4 yrs we owned it. I heard much worse examples at the time.
    Yes, the interest rate was 6% when we sold but right now, it costs more to sustain home ownership then it did in the late 80s when rates were over 10%. And right now, money is free!!
    I knew a friend that started a Real Estate company in the late 80s with 3 other guys.
    By mid 90s, they had to fold and were all broke, and each of them got divorced within a couple years. They were all in non-real estate jobs as well, following this.

  • Reply
    MR 1 day ago

    Many millennials, Gen Z’s, new immigrants are eagerly looking forward to give a piece of mind by their vote in the upcoming elections at all levels.

  • Reply
    Bob Walter 1 day ago

    It makes perfect sense that during a pandemic we want to stimulate people frantically packing up their stuff, moving and shopping at the furniture superstore. I figured the smart thing to do is stay put, lay low and don’t take any unnecessary chances. But not for real estate.

    Even before Covid the economy wasn’t doing that great (september 2019).

  • Reply
    Holton 1 day ago

    This stress test does not apply to B lender aka small banks and private lenders. This only make it harder for people to buy through big banks.

    Now with all the printed money all over the world house prices are going up everywhere not just Canada.

    With vaccination the world is on its way to recovery, if Canada crash housing prices now we are screwed.

  • Reply
    Andrew Dold 1 day ago

    Trying to engineer a market rather than allowing the free market to sort it out causes un-intended consequences. This will probably blow up in their face and actually cause the housing market to heat up even more.

  • Reply
    straw walker 23 hours ago

    A little late…the horse is already out of the barn..sounds more like a political move than one done on necessity.

  • Reply
    Ronald Murphy 11 hours ago

    If the government is so interested in protecting Canadians from getting overextended in debt, perhaps there should be a qualifying process for credit cards and car financing. Mortgages at 2% pose less of a problem than credit cards at 20% with ever-increasing limits and car loans almost equal to annual income. They are chasing the wrong issue. In fact, the government is blocking people from refinancing their way out of the high priced debt by putting limits in place on housing debt but letting the horses out of the barn on all other more expensive forms of credit. Have any of you heard of a stress test on credit cards or car loans? Not likely, because they don’t exist. In fact, if you can fog a mirror you qualify for a new F150 pickup truck financing. Mortgages for shelter should be third in priority in the grand scheme.

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