Canada

Canadian Banks Begin Circumventing Mortgage Stress Test For High-Income Clients

A new mortgage stress test? Don’t bother me with those peasant details. After Canada’s property bubble attracted global criticism, they announced tighter mortgage lending. On April 8, the Office of the Superintendent of Financial Institutions (OSFI) said they would make the stress test harder. By the following Monday, the first bank launched a pilot mortgage program to increase the maximum mortgage size. They just didn’t do it publicly.

Uninsured Mortgage Stress Test

The OSFI B-20 Guideline, a.k.a. the stress test, checks a borrower’s income against higher rates. Instead of checking if a borrower can afford a mortgage at a contract rate, they see if they can pay a much higher one. They use the contract plus 2 points, or the Bank of Canada’s benchmark rate. This reduces the maximum mortgage a household can borrow, ideally lowering risk.

The idea is to allow borrowers to enjoy the benefits of lower interest rates, without spending more. Often when rates are lowered during a hot market, home prices just absorb the slack. If tested at a higher rate, the borrower gets the benefits of cheap debt, without spending more. It also ensures they can afford the payments, and the economy doesn’t give more points of spending to housing. It’s an all-around win for the most part.

OSFI Tightens Stress Test By Raising The Floor

Just a few days ago, OSFI said they would be increasing the rate of the stress test to further reduce buying power. The benchmark rate used as a floor in calculations increased from 4.79% to 5.25%. This reduces the max borrowing power using the benchmark by 4.5%, compared to the current level. Theoretically, of course.

Typically the maximum mortgage a household can service is calculated using debt service ratios. There are two ratios — the gross debt service (GDS) and total debt service (TDS).  A borrower’s monthly payments need to be lower than both of these ratios.

The GDS is the maximum income that can be used to pay for a mortgage. This includes the principal, interest, taxes, and heat (PITH). If you’re buying a condo, you also need to typically add half your maintenance fees as well. Most lenders cap the GDS at 35% of income, meaning payments need to be under this level.

The TDS is the maximum income that can be used to pay for PITH, and other debt servicing costs you might have. This includes your GDS costs, as well as all of your other monthly debt servicing costs. Car payments, credit cards, that Thigh Master you financed for the past 30 years, etc. These are included in this number, to make sure you aren’t pushed to the brink. Most lenders cap this number at 42% of income, and all debt needs to be lower. If your other payments are more than the difference between the GDS and TDS, you lose a little room from your max GDS.  

Scotiabank Launches Pilot Mortgage Program For High-Income Borrowers

Scotiabank is the first bank to launch a pilot to increase leverage post-update. As of April 12, 2021, the bank has launched a hush-hush pilot program that raises the TDS to 50%, with no specified GDS. An agent explained this means they’ll approve the GDS on a case-by-case basis, up to the TDS. As long as it fits within the risk profile for the lender.

Borrowers in the pilot wouldn’t see their leverage drop 4.5% from today’s levels, after the stress test increase. Pilot participants actually see their budgets increase by up to 40% from before the OSFI announcement. Lending standards are loosening for some, while tightening for others. 

Pilot For High-Income Borrowers In BC, Ontario, and Quebec

The pilot is for branches in B.C., Ontario, and Quebec, and applies to ideal mortgage borrowers. The application’s uninsured bureau risk indicator (BRI) must be A-rated. There can only be two borrowers on the application, and their combined income needs to be over $120,000 per year. The automated system will pre-determine if the borrower fits these low-risk criteria. 

Don’t bother looking for the details of the program on their website. The program is conducted in the strangest way I’ve ever witnessed. Customer service wouldn’t acknowledge its existence by phone. Only hinting if the branch said it existed, it definitely does exist. I could almost hear the wink through the phone.

Even more weird was the response from headquarters. They’ve answered almost every question we’ve ever had. Except for this one. The bank declined to comment when asked to confirm the details obtained from a branch. Multiple branches confirmed the details, so it’s unclear why they wouldn’t. It’s weird when getting the details of a mortgage program from a bank feels like trying to score Molly, but here we are. Life in a property bubble.

OSFI Does Not Dictate Debt Service Levels, But Is Monitoring Them

OSFI confirmed Guideline B-20 allows federally regulated financial institutions (FRFIs) to adjust the TDS. The Guideline doesn’t dictate a limit. However, they are monitoring the debt service levels for risk. The regulator expects FRFIs to take extra measures to manage any additional risk they may take on. 

Is this more risky lending? Not really. A lot would need to happen to an uninsured mortgage borrower for the bank to lose. Prices would need to drop more than their substantial downpayment of more than 20%. Mortgage rates would have to more than double, to make it more difficult to carry on the same income. The borrower would also have to not pay their bill for an extended period of time as well. Honestly, the risk is pretty low for the lenders. Personally, it would be surprising to not see other banks roll out similar programs once they find out.

The pilot program does bring into question whether a higher stress test makes sense though. While it lowers leverage for some, the rules don’t apply to everyone. In cities like Toronto and Vancouver, a borrower’s income would have to clear the pilot’s hurdle for even the cheapest homes on sale now.

The only differentiating factor would be credit quality. As we learned during the US housing crisis, high credit scores didn’t actually change the outcome. Investors with high credit scores were the demographic to show the largest growth in defaults. It turns out using precedent to determine how someone acts during an unprecedented situation, isn’t all that helpful. 

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32 Comments

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  • Trader Jim 6 months ago

    Most banks will make exceptions to mortgage leverage if it’s uninsured since they take on all of the risk. As long as they can secure the proper collateral.

    You’re correct though, it’s low risk for the bank. The borrower better actually has rock-solid financials though, and not just borrowed a loan from their parents. I’m not saying they’re going to lose money, but in a worst-case scenario, the borrower is the only one that typically loses anything. The bank won’t be the one losing much if anything.

    • Kris 6 months ago

      The banks are not actually taken on all the risk. These loans are bundled and sold with other conventional loans as mortgage backed securities. In many cases these bundles are securitized and insured by the CMHC. Now here is a shocker for you …. This also happens in the private mortgage lending world as well to a degree. Some of the large MIC’s (Mortgage Investment Corporations) bundle and sell too. This is essentially tax payer funded insurance for the wealthy and the banks.

  • D 6 months ago

    How long before interest rates crawl back to above 5%?

    • James Ling 6 months ago

      Decades

      • D 6 months ago

        Keep dreaming

        • James Ling 6 months ago

          I’m not dreaming I just understand economics and exporting. It took a decade to raise it a few points and that was in tow with the US. The US will be leaving the rates low in order to pay for all of the government borrowing, and Canada isn’t going to be able to move more than 25-50 basis points outside of the US. You really need to analyze things in reality.

        • Oops 6 months ago

          It’s not dreaming there’s no driver for higher rates. You have an abundance of capital with no where to go. I’m in agreeance.

    • Kris 6 months ago

      The Gov will do whatever it takes to prevent that from happening and if they can’t they will just modify mortgage lending regulations. For example 35, 45 or even 50 year amortizations, loan modification programs to extend existing amortizations etc…. These politicos are knees deep invested in housing themselves.

  • Bob Walter 6 months ago

    If you are smart you don’t need OSFI, the Government, Banks nor realtors to tell you what you should borrow for your house.

    A sound guideline is paying a maximum 30% of your pre-tax monthly income on housing, which includes property tax, insurance.

    • Tom Wolfe 6 months ago

      I agree Bob, but if property values rise today, property taxes rise tomorrow. I bought in 1993, and the property taxes were $3500. Now they are approaching $20,000, or $1600 a month. That’s higher than my mortgage payment at that time.

      Fortunately on a $3M house, with $2M mortgage at 2.5% , the monthly mortgage payment is about $9,000. Add the monthly property tax of $1,600, for a total of $10,600 a month. Pretax income has to be only $425,000 per year. Easy-peasy 🙂

  • Chewy 6 months ago

    10 years.

    Using 2009 as a benchmark.

  • Average Man 6 months ago

    A household income of over 120k!? That’s IT!? That’s NOTHING! This is gonna be so bad.

    • Jason Chau 6 months ago

      Presumably the only buyers that don’t clear the income hurdle in those regions are people who already own, who are upgrading.

      I don’t know how hard a BRI A is to get though. Is that like an 800 credit score, or higher?

  • Smaug 6 months ago

    $120K for “maximum two applicants”. Scotiabank needs to hire a new analyst to do some inflaton indexing. 120K for a couple was a high income back in 1986. Today it’s enough to buy a 1960’s bungalow in Fredericton.

  • Jason Chau 6 months ago

    This is actually the most bearish thing I’ve seen. The market can’t take any deleveraging.

    I figure the stress test had a minimal impact.

  • Jake 6 months ago

    This article keeps referring to the banks being hush as being weird. I have to say its pretty obvious and I would like to hear more on this topic. If you live in this country, or have grown up in this country it is now harder then ever to own property. But the point is that ‘they’ are making it easier for the wealthy to own more and harder for a single $85k/yr income household to own their own home. Governments try to keep telling us that they are trying ro bring equality to ‘all’, but that is just not the case.

  • LS 6 months ago

    You say this like it’s new. All the big banks have been bypassing the stress test for well qualified borrowers for at least the last year. Scotia is doing the same thing everyone else is doing.

  • Ben 6 months ago

    This product seems designed for people holding multiple properties who will never conform to a traditional gds,tds model no matter the income. Presently many have to use alternative lenders and not the big banks.

    • Mortgage Guy 6 months ago

      It’s not. It’s a primary residence. It’s to scoop business from monoline lenders. I don’t know why you would conclude that without any other details. I know someone that was recently approved in it.

  • Vince 6 months ago

    I’m curious why the author keeps referring to the market as being in a bubble. While I agree that housing is unaffordable the fundamentals are that over the past year households have been saving at rates not seen for many years due to the pandemic. Property values have appreciated over that time and people are in a good position to be purchasing houses. I can’t speak for the entire country but here in the lower mainland and on Vancouver Island the supply of houses on the market is much smaller than in previous years. This is basic economics lots of supply short demand increase in prices. This is basic economics. The world population is getting higher, people are looking for safe investments, in a stable economy. Capital markets are at all time highs now and in my opinion present more risk than the housing market. Moreover, when the housing market corrects, not bursts, it will likely be in the matter of 10 to 15% which is a year of appreciating values. Give or take a housing market increase of 1% to 1.5% a month. If homeowners can’t absorb this then the current stress has fails. But I would be hesitant in any situation to call this a housing bubble especially given the massive price gains over the last 12 years. At any point in the last decade we could have refer to the market as a housing bubble. News articles like these while informative on Bank rates give the impression that we’re in some sort of crisis and that’s just not the case.

    • Winnie The Pooh 6 months ago

      Because the government called it a bubble. Keep up.

      • Vince 6 months ago

        Winnie, cite where a government official has referred to the market as a bubble.

        • Ottawa Resident 6 months ago

          Dude. If you have no clue what you’re talking about, you shouldn’t be rude to people.

          The government official was having a public discussion with the author when he said it.

          Catch up. What are you like a real estate agent in some small rural town? The guy that wrote this piece is the person who does the reports for the governments and basically any hedge fund that deals with Canadian credit.

          If he wanted to crash the market, he could literally just tell Millennials to not to buy. He just doesn’t.

    • Oops 6 months ago

      The very things that make this country a “safe” haven are the very things being undermined by the ridiculousness of the housing market: prosperity and industry. Both will die as more productive capital is absorbed by the FIRE industry and you make your country brutally uncompetitive globally with land value inflation and leading G7 consumer/govt debt values. Also social safety nets will need to get paid for somehow and since there’s no wage gains from productivity, something will need to be taxed. There is no such thing as a highly taxed Monaco, you’ll do well to remember this. Don’t say tech because a branch plant of an American company does little for our industry.

      And LOL at the bit about the housing market being more robust than equity markets. The bulk of the housing gains in this country are driven by debt and foreign “investment.” You think it’s wise to put your savings into this tiny country’s seemingly “robust” over the monopolies (with fat margins) of the empire down south of us? Get real. If their equity bubble continues with the FED, so will ours. Absurd to think we can print our way out of this or flood the country with immigrant labour to deliver UBEREATS and work for 40-60k per year for eternity.

      Get real.

      I’ll keep most my savings with the Americans. I suggest those reading do the same.

  • John smart 6 months ago

    120k is high income? Seems pretty middle class to me

    • Ottawa Resident 6 months ago

      Cute. It’s 50% above the median household income, and Toronto has one of the lowest medians in the country. I make multiples of that, and I’m not trying to dismiss it’s a lot of money compared to what most make.

      • Oops 6 months ago

        Middle class was a sociocultural definition. It’s more complex than looking at the distribution of incomes and finding the middle 45-55 and calling it a day.

        Reality is that 100-150 is basically middle class in the mid decade of 2010s and you can enjoy a condo in Toronto. Wage gains are not powering the city, debt and speculation is. You cannot be middle class if you are questioning your finances continuously. Historically, the middle class was never really insecure. Today, you are very much wondering what your future is with 100-150k per year in a city where housing values are being juiced up to the tits every year. One wrong move and you’re left to live in a tiny shoebox unless you enjoy commuting for hours. Doesn’t sound middle class at all to me. The upper middle class (for now) enjoys the security that the middle class once did. These are the professionals and managerial class. The security is a critical component of the definition of “middle class.” You simply cannot be middle class if you are insecure, ESPECIALLY about owning housing.

        Don’t even get me started on the threshold to become “rich” post 2008 GFC QE. To become a member of the asset holding class you have to really kill it.

  • Kris 6 months ago

    That’s what the debt ratios used to be. I remember back in the early 2000’s when the Gross debt service ratio was 30% and the Total debt service ratio was 40%. You could actually buy a home and feasibly strive to pay it off one day.

    • Mortgage Guy 6 months ago

      They can keep expanding debt ratios or amortizations, but it ultimately leads to slower future economic growth. Every year you add, you remove a year of that person spending into the economy.

      The government would have to be exceptionally incompetent to execute on that.

  • Steve Zullo 6 months ago

    Hi. Scotia and a couple lenders have always done this. I”m mortgage broker and can already get GDS and TDS of up to 47% fairly easy for decent clients. They don’t need $120K income, but good credit. Not a big deal and they’ve always done it. So do the other banks. This is for conventional files only, when client has more than 20% down. If anyone wants access to this program, let me know.

    I can even get 70% TDS through another national lender with an incredible Home Equity Line of Credit. My understanding is that banks are allowed to have a small percentage of their portfolio in ‘non-conforming’ mortgages and that’s what these products are.

    • Mortgage Guy 6 months ago

      Literally not true. This is an automated validation program that was rolled out on April 12. Part of the reason they aren’t discussing it is because it’s not available to the broker channel.

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