Canada’s banking regulator is proposing big changes for housing finance, with potentially three new limits on how lenders grant mortgages.
The proposal comes after the Bank of Canada has ramped up interest rates by four percentage points since March 1, the average Canadian home price has plunged 22.4 per cent in the past nine months and the threat of recession looms.
On Thursday morning, the Office of the Superintendent of Financial Institutions (OSFI) released the new proposed mortgage guidelines for public comment.
Essentially, OSFI wants to skim another layer of the least-qualified borrowers off the federally regulated mortgage market. But how they’ll do that is not yet determined.
“We’ve thrown out some ideas we’re considering,” OSFI Superintendent Peter Routledge told The Globe and Mail in an interview. “We’re opening up the consultation early. We want ideas. We want constructive critiques. We want to hear from players in the system.”
According to the Thursday release, among what’s being considered are:
New restrictions on mortgage size and debt loads
These measures would restrict how much a bank can lend to borrowers whose mortgage, or total debt, exceeds a certain percentage of their gross income. For example, OSFI may require banks to ensure that no more than 25 per cent of their mortgages have a loan amount that’s greater than 4.5 times the borrower’s annual income. Compared with today, by my estimate, this would limit mortgage amounts for maybe 5 to 10 per cent of borrowers.
New debt-service coverage restrictions
This change could further limit how much a borrower’s mortgage payment or other obligations can be as a percentage of income. Most banks, for example, limit a borrower’s housing obligations to 39 per cent of gross income, or less. Thus far, OSFI hasn’t capped this number. Now it might. And it might limit the debt ratio exceptions lenders make to get around its borrowing stress test.
New interest rate affordability stress tests
OSFI says it may implement a new minimum interest rate that is applied in debt-service coverage calculations to test a borrower’s ability to afford higher debt payments in the event of financial shocks. Examples of potential shocks include loss of income, soaring interest rates and divorce. Among other things, it’s possible that the qualifying rate might be different for different mortgage terms, such a one-year fixed and a five-year fixed.
In his interview with The Globe, the head of OSFI touched on what he expects lies ahead.
“Debt serviceability is among the strongest it’s ever been,” Mr. Routledge explains. “99.86 per cent of Canadians are current on their mortgages.” That’s the lowest arrears in recorded history.
“We’d like to keep that going,” he says, while acknowledging, “It probably could deteriorate a little bit from here.”
The Superintendent adds that he’s “quite confident” after stress-testing banks that Canada has “a lot of resilience built into the capital and liquidity of those institutions.” He says that would enable them to withstand a major shock, like a U.S.-style housing crash and extreme unemployment.
“What we’re doing today is to ensure that residential mortgage credit underwriting quality remains high,” Mr. Routledge says, adding that OSFI is preparing early for “unforeseen risk” over the horizon.
Although OSFI says it’s only starting the public consultation process, when a regulator goes through all this effort and expresses concern about borrowers being able to pay their mortgages in the future, it is prepared to act. While OSFI wouldn’t predict when its final guidelines will be announced, I’d bet sometime around the summer.
The Globe and Mail
I see three main impacts from Thursday’s announcement:
1. Fewer borrowers will qualify for a mortgage with a federally regulated lender, like a bank.
As proposed, banks would potentially have to reduce how many mortgages they grant to borrowers with high ratios of debt to income (those with mortgages over 450 per cent of their income, for example).
OSFI could also put a hard limit on traditional debt ratios, which banks use to underwrite borrowers. Today, banks make exceptions for creditworthy high-debt-to-income borrowers – so long as they have significant assets or other risk mitigants. That may end or be curtailed.
On top of that, OSFI may somehow raise the minimum interest rate borrowers must prove they can afford.
2. More borrowers will pay up for non-prime mortgages
When bank credit becomes more restrictive, borrowers increasingly search out less-regulated lenders where it’s easier to get approved. That flexibility comes with higher interest rates and fees, which raise default risk for these borrowers. OSFI suggests this is an immaterial risk for the banks it regulates – but if you’re the borrower assuming this risk, it’s material.
3. It could add slight downward pressure to home prices, other things being equal
Some will argue that OSFI’s timing could exacerbate the housing sell-off. After all, home prices in many regions have fallen off a cliff, affordability is stretched with lofty interest rates and we’re likely headed into recession. We also just got a foreign-buyers ban, there’s a new anti-flipping law, federal and provincial governments have enacted a slew of new real estate-related taxes, and in February Basel III, an international regulatory framework for banks, is going to further tighten mortgage capital requirements. It’s probably fortunate that the implementation date of these changes is several months out, at least six months is my guess.
Is it necessary?
Few would argue that a safer housing market isn’t better. But just like a speed limit on a highway, set the limit too low and the cost exceeds the benefit.
Despite the most aggressive rate hikes and housing correction in decades, Canada’s housing finance system remains rock stable by most industry metrics. That leads to many questions, like how many more credit restrictions are politicians and homeowners willing to accept, how much more are they willing to pay for non-bank mortgages, and how many more first-time buyers should be shut out of home purchases – all to guard against low-probability unknown risks that may never come.
OSFI was dead-right and deserves tremendous credit for implementing the controversial mortgage stress test in 2018. Without it, the housing balloon would have blown up too big before it popped.
Is our bank watchdog also right this time? Or have mortgage regulations passed the point of diminishing returns?
Once the consultation opens this week, the general public and industry will get to share their opinion with the regulator directly.
Watch Robert’s full interview with OFSI’s Peter Routledge.