What? Two posts on mortgage regulations in one week! You must have been a delight in a past life. Proposed changes from the Office of the Superintendent of Financial Institutions (OSFI) have left people with a few misconceptions about stress testing. A few real estate bears have been assuming this is the end for any homeowners that are already stretched thin. The thought is a little scary to a lot of people, so I thought I would get a breakdown from OSFI themselves.
Proposed Stress Testing Rules
The OSFI B-20 proposal, if implemented, would subject uninsured mortgages to a whack of new rules. The most interesting (and most misunderstood apparently) is the mandatory stress testing of new mortgages. Stress testing involves lots of checks and balances, but the biggest changes are checking if borrowers can handle an interest rate hike of 2% more than they’re paying, and re-calculation of the loan-to-value (LTV) ratio. Keeping records, and ensuring people can afford the home they’re buying? Total outrage!
The real issue isn’t stress testing new mortgages. As I pointed out yesterday, only Vancouver and Toronto would really get a s**t kicking from the new proposed rules. The issue is, there’s dozens of forum threads, and financial insight blogs claiming that many existing homeowners that may have overpaid in some markets, won’t qualify on renewal. That’s not exactly true.
Stress Testing Rate Hikes
OSFI confirmed to us that under the proposed guidelines, existing borrowers would not be subject to stress testing of rate hikes if they renewed at the same financial institution. Borrowers that just renew at their existing lender, won’t technically have to prove that they can afford their mortgage at a higher rate. However, those planning on locking in a better rate at another bank, would have to undergo the whole stress-testing process like a new borrower. Many people won’t have the freedom to shop for the lowest rate, but they aren’t going to lose their homes because they can’t prove they can handle an outlying scenario of a 2% hike on their mortgage rate.
Stress Testing LTV Ratios
What happens if your home value experiences a massive drop, and your mortgage falls below the threshold of being uninsured? If you’re moving to another financial institution, you could be straight up f**ked if you borrowed too much. You’ll have to undergo stress testing, and prove you can carry a rate 2% higher than you have to pay.
If you are renewing with your current lender, that’s less clear. OSFI directed me to this line: “FRFIs should update the borrower and property analysis periodically (not necessarily at renewal) in order to effectively evaluate credit risk. In particular, FRFIs should review some of the aforementioned factors if the borrower’s condition or property risk changes materially.” If you’re not a policy nerd, that pretty much says they don’t have to check on renewal, and there’s no real time frame for when they will update it. It also suggests reviewing some factors, in the event a borrower’s “condition changes” (i.e. stops paying their bills on time), or “property risk changes materially” (i.e. there’s market capitulation).
Widescale capitulation of real estate markets, and regulators will have bigger issues than a few people paying their bills on time. Your lender doesn’t want your home, they want the interest on your mortgage payments. It’s not exactly in their best financial interest to voluntarily update the LTV ratio of your home with regular frequency, and extreme accuracy to kick you out. They could, but that’s at their discretion and it doesn’t make a whole lot of financial sense to try and seize homes that are dropping in value.
Meet Your New Predator, The Big 5
The most interesting thing is borrowers at risk of failing a refinance stress test, won’t be able to shop around for better rates. Almost all of the leverage falls into your existing lenders hands, and they’ll know you can’t leave. This could result in less mortgage competition, and higher borrowing rates than if you could just walk down the street and get a better rate. With half of all Canadian bank profits coming from mortgages, and growth set to taper – you better believe someone is going to pick up the slack. Ironically, those that can’t afford to do another stress test, will probably end up paying much more than those that don’t. So it’s not exactly all rainbows and unicorns for those that already own.
Update Sept 29, 2017: OSFI contacted us to remind people there will be an LTV exercise under the proposal, just not necessarily at renewal. Here’s the exact words they used:
The institution may do the LTV exercise at renewal, but not necessarily – it is a case by case situation.
Each loan and insurance underwriting circumstance is unique and lenders and mortgage insurers need to use appropriate judgement and are expected to conduct sufficient due diligence and have in place adequate processes, consistent with the guidelines.
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