Canada's banking regulator is tightening rules for mortgages, adding new hurdles for home buyers at risk of becoming overstretched in the country's hot housing market.
On Thursday, the Office of the Superintendent of Financial Institutions (OSFI) released a draft guideline designed to "strengthen expectations" and shore up underwriting practices. But the proposed rules, which include new stress tests for uninsured mortgages, would also make it harder for some would-be homeowners to qualify for certain loans.
The updated rules would require lenders to stress test all uninsured mortgage loans – those with down payments of at least 20 per cent of the purchase price – at a higher rate, whether fixed-rate or variable and regardless of term. The borrower would need to show they could withstand a rate two percentage points higher than the rate on offer, similar to the standard the federal government mandated for insured mortgages last fall.
The proposals for tougher standards come as regulators and banks express concern about surging price increases in some of Canada's largest cities.
Governments have introduced new measures to try to cool overheating markets, from stricter federal stress-testing requirements to provincial foreign-buyers' taxes. Yet, with interest rates low and supply still tight, worries about risky borrowing persist.
In the Toronto region, there are signs of a slowdown as sales and prices slumped in June, according to Toronto Real Estate Board data. But there are also lingering concerns about underwriting standards as leading alternative lender Home Capital Group Inc. recovers from a crisis of confidence, sparked by poor disclosure over fraudulent documentation from some mortgage brokers.
The proposed guidelines also seek to stamp out a practice of bundling mortgage loans, which OSFI thinks is against the spirit of its regulations. Currently, a loan must be insured if it exceeds 80 per cent of the value of a home. But some lenders help borrowers sidestep that threshold by bundling together a second, smaller loan from a private unregulated firm, such as a mortgage investment corporation, or MIC.
Such arrangements have been most common among alternative lenders such as Home Capital and Equitable Group Inc., which manages the loans as a single payment. Now, OSFI is promising to outlaw "co-lending arrangements that are designed, or appear to be designed to circumvent regulatory requirements."
"That's certainly not how I think about them," said Andrew Moor, chief executive officer of Equitable Group, where bundled loans account for less than 10 per cent of the total mortgage book. "Really, our view is it gives us another risk-management tool. Clearly, the most risky dollar in any loan is the last dollar."
A spokesperson for Home Capital said the company "discontinued its bundle program" earlier this year "as it was not supported by the economics of the market." The company is evaluating the potential impact of OSFI's proposals.
A year ago, OSFI published a public letter promising to scrutinize underwriting practices more intensely and to review guideline B-20 – last adjusted in 2014 – which sets out the due diligence, appraisals and paperwork lenders must perform. The B-20 changes would help level the playing field where stress testing is concerned. Tougher tests for insured mortgages introduced by the federal government last year disproportionately affected non-bank lenders. But the new guidelines would force big banks to conduct similar tests on uninsured mortgages – which make up 46 per cent of residential mortgages at Toronto-Dominion Bank and 52 per cent at Royal Bank of Canada.
"All of a sudden, now the banks … will have to play by the same set of rules," said Dan Eisner, co-founder and CEO of True North Mortgage. "So this will shift power."
The Canadian Bankers Association is reviewing the proposal to give feedback to OSFI. Neil Parmenter, the CBA's president and CEO, noted that Canadians have "demonstrated that they are prudent borrowers."
Even so, the tougher qualifying standards could squeeze some of those buyers and to Mr. Moor, that appears to run counter to the federal government's housing strategy. "I think there's a big desire to help the middle class get on the housing ladder and that includes, in particular, immigrants and self-employed individuals that tend to be our focus," he said. "Frankly, we're a bit concerned that these measures disproportionately impact those people."
If the changes go through as proposed, some prospective homeowners could see their buying power fall by roughly 18 per cent, according to Robert McLister, founder of mortgage-comparison tool RateSpy.com.
"From a consumer point of view, this is bad news," Mr. Eisner said.
The regulator is accepting comments until Aug. 17 and expects to issue the final guideline this fall, to take effect "shortly thereafter." An OFSI spokesperson said: "Creditworthy borrowers will continue to have access to mortgages."