New bank stress test stricter on all home buyers

TORONTO — Canada’s banking regulator said Tuesday it is going ahead with a new stress test for home buyers who don’t need mortgage insurance, who will soon have to prove they can make their payments if interest rates rise.

The move is expected to reduce the maximum amount buyers will be able to borrow to buy a home, even if they have a down payment of 20 per cent or more, as of Jan. 1.

The Office of the Superintendent of Financial Institutions set out final guidelines on the changes to its residential mortgage underwriting guidelines Tuesday, the thrust of which are similar to what it proposed in a draft consultation in July and that had been criticized for potentially increasing costs and limiting access to mortgages for some buyers.

However, the regulator did tweak the calculation of the qualifying rate for uninsured mortgages, to address concerns that using the contractual rate plus two per cent could lead borrowers to seek out shorter terms.

“We didn’t want to create an artificial incentive for borrowers to shorten terms because of the regulation,” superintendent Jeremy Rudin told reporters.

Would-be homebuyers will need to prove they can still service their uninsured mortgage at a qualifying rate of the greater of the contractual mortgage rate plus two percentage points, or the five-year benchmark rate published by the Bank of Canada.

An existing stress test requires those with insured mortgages to qualify at the Bank of Canada benchmark five-year mortgage rate. Phil Soper, chief executive of Royal LePage, said most first-time buyers were probably already subject to a stress test, but buyers looking to move up to a larger home may be affected.

“Someone who is using the equity in their home to move from say a condominium to a detached home because they have had a baby or another baby, they may not be able to do that,” he said.

Soper said the change has increased the risk of a market correction, where home prices reset lower.

“I don’t expect that, but the risk certainly increased today.”

Other changes include restrictions on co-lending, or bundled mortgages — in which federally regulated lenders pair up with unregulated providers to finance a property — aimed at ensuring financial institutions do not circumvent or appear to circumvent rules that limit how much they can lend. Federally regulated financial institutions must also establish and adhere to loan-tovalue ratio limits that are updated as housing markets and economic dynamics evolve.

“We certainly see the risks that are caused by high household indebtedness, by the high house, property values in some markets ... and the risks posed by potential changes in interest rates,” Rudin said.

The government has tightened mortgage rules several times in recent years, including a change last year that expanded stress tests to all insured mortgage applications. Meanwhile, the Bank of Canada has raised interest rates twice in the past few months to the current overnight lending rate of one per cent.

Rudin also said he would consider revisiting OSFI’s uninsured mortgage stress test down the line and adapting it as circumstances change.

“We are prepared to revisit that if there is an evolution in interest rates over time,” he told reporters. “But right now I would expect it to be durable, because it is well lined up with the comparable test ... for insured mortgages.”

TD Bank senior economist Brian DePratto said data for August showed insured mortgages were down 4.5 per cent compared with a year earlier, while uninsured mortgage credit grew 17.3 per cent.

“While this is partly related to the rising prices of Canadian real estate, with more and more of it priced above the insurance caps, it also likely reflects the skew stemming from the past stress test requirements,” he wrote.

“As such, today’s change, alongside the explicit guidance around co-lending arrangements, will together help address the shift as far as those borrowing from federally regulated institutions.”

David Madani, senior Canada economist at Capital Economics, estimated that using a traditional 25-year amortization, the changes reduce the maximum house price a buyer can afford by about 15 per cent.

“Needless to say, these latest mortgage rule changes will have a negative impact on house prices and household wealth,” Madani wrote in a note to clients.

Rudin reiterated Tuesday that OSFI was aware the stricter guidelines for uninsured mortgages could have unintended consequences, such as sending borrowers toward more risky lenders that are out of the regulator’s purview.

“We can’t control what we can’t control,” he said.

“Our mandate is focused on the safety and soundness of the federally regulated institutions . ... It isn’t something that we favour, but it isn’t something that we have an authority to prevent.”