Robert McLister is a founder of RateSpy.com and intelliMortgage. You can follow him on Twitter at @RateSpy.
"Mortgage rules have a broad and direct impact on many people’s lives,” says the Office of the Superintendent of Financial Institutions.
You can say that again.
Since Canada’s most recent mortgage stress test began a year ago, more than one in 10 potential borrowers can no longer qualify for a bank mortgage, real estate prices are falling, homes are taking longer to sell, record numbers of Canadians are turning to costly higher-risk lenders and untold numbers of mortgage renewers are now paying higher rates.
On the other hand, new borrowers are now more protected from future interest-rate shock, less likely to overspend on a home and banks are slightly less likely to write bad mortgages.
So, net-net, it was all worth it, OSFI’s Assistant Superintendent Carolyn Rogers suggested in a speech Tuesday.
If you’re an affected homeowner, however, you’re probably not so sure it was.
Looking back at the new stress test one year later, the new rules have been both a saviour and – in some respects – a failure. It just depends who you ask.
Ask some renewers
The stress test, which requires federally regulated lenders to confirm you can afford a rate that’s at least two percentage points higher, does not apply if you simply renew your mortgage with your existing lender.
As a result, lenders industry-wide have enjoyed watching their customer retention rates climb. Last October, OSFI reported that renewals surged an unusual 30 per cent as of midyear while new mortgages were down 19 per cent.
As many as 100,000 renewers every year may be at risk of not passing the stress test, based on estimates from Mortgage Professionals Canada. And when a lender suspects you can’t qualify elsewhere, it has little incentive to offer you excellent renewal rates.
Worse yet, renewers who flunk the new stress test have no ability to switch to a lender with more favourable terms (such as lower penalties or more flexible refinance privileges). Better terms often save borrowers one to three times more than even a quarter-point interest rate difference.
“A stress test when switching lenders is purely anti-consumer,” says Ron Butler, a 23-year mortgage veteran of Butler Mortgage. “It’s an abuse of Canadian mortgage holders who deserve to shop for a better rate.”
Why trap borrowers?
In her speech, Ms. Rogers said OSFI does “not want borrowers who do not meet the increased underwriting standard to become the focus of price competition among lenders.”
To that, everyone should ask, “why not?” The higher the interest rate, the lower a typical borrower’s cash flow and the more likely they are to default. The stress test effectively strands renewing customers with their lender, even though switching lenders lowers the risk of default.
But more to her point, it’s highly unlikely lenders are about to start chasing higher-indebted borrowers with their lowest rates. A federally regulated lender’s default rates and average borrower debt ratios are intimately scrutinized. If a bank’s portfolio got too heavy with high debt-ratio borrowers, it would have little option but to curtail that business. That means renewer risk would be spread out among multiple lenders, just like it is today.
Even if banks did theoretically pursue such business, “Mortgages at renewal statistically have the lowest of the low default rates,” Mr. Butler reminds us. It simply does not follow that lenders attracting these borrowers on price would amass a concentration of “dangerous” mortgages. Indeed, this borrower risk is already in Canada’s government-backed mortgage system.
What’s the data show?
“To date we haven’t seen any evidence that banks are taking advantage of this situation to the detriment of borrowers,” Ms. Rogers said Tuesday.
Maybe that’s because policy-makers aren’t tracking the right data.
Approached for comment, an OSFI spokesperson confirmed the regulator does not have data on the renewal rates being paid by borrowers with higher debt ratios – the ones affected by the stress test.
OSFI gets such data from lenders and "federally regulated institutions are generally not required to re-underwrite loans at renewal,” she said. That “precludes” OSFI from gauging how much more renewers who don’t pass the stress test are paying.
But ask most high-volume mortgage advisers and they will testify to one thing: It’s become normal to see borrowers at maturity not qualifying with other lenders – simply because their debt ratio exceeds the new stress-test limit. That’s even though they easily would have qualified under the old rules – rules that had kept defaults low for decades.
A flaw in logic
Renewing borrowers have already been stress tested. And they’ve already proven they can make all their mortgage payments on time. Exempting the current lender from the stress test, but not a competing lender (the one with the better rate and terms), is virtually nonsensical.
The renewing lender generally doesn’t re-underwrite the mortgage. So, it has less insight into how likely the customer is to pay going forward, versus a brand-new lender that fully reviews the borrower’s income, employment, credit report, property and other expenses.
“The borrower [who renews elsewhere] will be far better underwritten than at the incumbent lender who just fired off a renewal offer after checking for arrears,” Mr. Butler states.
Certain supporters of a stress test on lender switches argue that if borrowers want a better mortgage, they should pay off debt so they can pass the stress test. Unfortunately, that fails to recognize the life hardships that cause many people to rack up debt in the first place: divorce, job loss, illness, death of a spouse, business failure and so on. It’s easy to be callous and tell people to suck it up and pay a higher rate. But that doesn’t help people struggling to make ends meet, and it doesn’t reduce system-wide risk.
A glimmer of hope
Making exceptions on stress tests is not without precedent. The Department of Finance allows default-insured borrowers to avoid its stricter stress test when changing lenders, so long as they got their mortgage before Oct. 17, 2016, and are adding no new risk.
Allowing a stress-test exemption for uninsured borrowers is rational, so long as the applicant has enough equity, meets all other government and lender mortgage requirements and proves they can afford a mortgage at the lender’s five-year fixed rate.
Thankfully, OSFI hasn’t ruled out a future stress-test exemption just yet. “We will continue to monitor this and will continue to report our observations publicly,” Ms. Rogers said. “If we see the need to take action, we will.”
Good on them for leaving the door open to fixing a very unnecessary problem.
Robert McLister