Mortgage stress test rules may change as interest rates climb and housing market cools, says regulator

Canada’s banking regulator is leaving the door open to tweak its mortgage stress test before the end of this year, as the cost of borrowing soars and the housing market starts to cool across the country.

Although the Office of the Superintendent of Financial Institutions expressed satisfaction with the current rules, the regulator said it could revisit them again ahead of its annual stress-test announcement scheduled for mid-December.

“If conditions change, we reserve the option to come back more frequently than annually and that is very much part of our approach and indeed that’s true of any piece of guidance we have at OSFI,” Ben Gully, the regulator’s deputy superintendent of supervision, said on a call with reporters to discuss organizational changes.

Did OSFI make the right call on the mortgage stress test?

“We’re continually reviewing it, their applicability and, if conditions warrant, we would obviously move off cycle to address them,” he said.

Since OSFI toughened the mortgage stress test last June, the country’s housing market and borrowing conditions have changed significantly. The regulator must grapple with whether its rules are still effective in the current environment.

OSFI rules apply to borrowers who do not require mortgage insurance, which occurs when borrowers make a down payment of at least 20 per cent of the property’s purchase price. The regulator requires borrowers to prove they can make their mortgage payments at an interest rate of 5.25 per cent, or 200 basis points above their mortgage contract, whichever is higher.

But now, fixed-mortgage rates are quickly rising as the Bank of Canada embarks on an aggressive round of interest-rate hikes, and could soon top OSFI’s minimum qualifying rate of 5.25 per cent.

Today, the average five-year fixed-rate mortgage has an interest rate of 4.19 per cent, according to mortgage brokers. That is up from January’s average of about 2.69 per cent. That means that a borrower must now prove they can make their mortgage payments with an interest rate of 6.19 per cent if they want a fixed-rate mortgage, which is already above the 5.25-per-cent stress-test floor. And the stress test will become even harder as mortgage rates continue to climb.

That will drive more borrowers to variable-mortgage rates, as well as to non-bank mortgages – which typically have higher interest rates than chartered banks.

Already, borrowers are seeking variable-rate mortgages, which are at about 2.4 per cent today, according to mortgage brokers. “Qualifying for more money under a variable rate is a new phenomenon based on the recent rapid rise of fixed rates,” said Elan Weintraub, co-founder of Mortgage Outlet Inc.

Borrowers are also turning to alternative lenders such as trusts and private mortgage-investment companies, which do not have to comply with federal banking rules.

Samantha Brookes, chief executive officer of Mortgages of Canada, said her clients are now flocking to alternative lenders. Today, the vast majority of her customers are borrowing from an alternative lender compared with about half her client base at the beginning of this year. “We’ve seen a huge increase over the last couple of weeks,” she said.

The mortgage stress test was first introduced during the 2016-2017 housing boom to ensure that homebuyers could afford their mortgage payments if interest rates rose, as well as to slow the frenetic markets in Toronto and Vancouver. It falls under OSFI’s swath of residential lending rules, also known as B-20.

Asked on the call whether OSFI was comfortable with the stress test in the current rising rate environment, Mr. Gully said: “We’re comfortable that the expectations set out in B-20, the work that we do in supervision and the actions taken by the institutions we oversee put us on a course to preserve resiliency in the financial system.”

The stress test also applies to borrowers who require insurance or when a borrower makes a down payment under 20 per cent, though that is specifically overseen by the Finance Department. Typically, OSFI and the Finance Department work in tandem on the stress test.

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