OSFI's Proposals: New Mortgage Lending Restrictions
On January 12, 2023, the Office of the Superintendent of Financial Institutions (OSFI) announced that OSFI is considering new mortgage lending restrictions in an effort to mitigate increased risks stemming from high household debt. As of today, the proposed new rules are subject to public consultation.
What does OSFI do?
OSFI supervises and regulates financial institutions and pension plans as an independent arm of the Government of Canada.
The objective of OSFI is to protect depositors, policyholders, the financial institution (FI), creditors, and pension plan members.
OSFI also guarantees bank deposits through the Canadian Deposit Insurance Corporation (CDIC).
The OSFI acts as an information hub for Canadian financial institutions. They periodically post important news and guidelines for the member banks.
OSFI's New Regulatory Proposals
These proposals are focused on debt serviceability measures that include:
1. Loan-to-income (LTI) and debt-to-income (DTI) restrictions – Federally regulated financial institutions current don’t have prescribed LTI or DTI limits, however OSFI considers measures that restrict mortgage debt or total indebtedness as a multiple, or percentage, of borrower income.
LTI- mortgage debt relative to borrower income,
DTI- total indebtedness relative to borrower income.
The idea behind this restriction, if it comes into effect, is to control the extent of indebtedness. From the OSFI perspective, lower indebtedness reduces the probability of borrower default by making ongoing debt payments more manageable and limits a lender’s potential losses in case of borrower default.
OSFI is therefore proposing a “lender-level” limit that would restrict lenders to a certain volume of loans that exceed a “prudent” threshold. To operate effectively, OSFI is considering:
"A clear and consistent definition of “income”, for the purpose of calculating LTI;
Appropriate “high” LTI thresholds (e.g., 3.5x, 4.5x), in view of different macroeconomic conditions, and through-the-cycle; and,
A credible, industry-wide LTI volume limit (e.g., 20 – 30%)."
2. Debt service coverage restrictions – measures that restrict ongoing debt service (principal, interest and other related expenses) obligations as a percentage of borrower income.
Debt service coverage ratios are already employed by federally regulated lenders, with the Gross Debt Service (GDS) and Total Debt Service (TDS) ratios most commonly used. For the insured mortgages in Canada (with a down payment < 20%), GDS and TDS limits are prescribed in law and are currently set at 39% and 44% (Credit Score of < 680), respectively. Under 680, the maximum GDSR is 35%, and the maximum TDSR is 42%.
Beyond those requirements, B-20* does not articulate limits on GDS and TDS for uninsured mortgages and generally permits Federally Regulated Financial Institutions (FRFIs) to establish debt serviceability metrics under their Residential Mortgage Underwriting Policy (RMUPs) that facilitate an accurate assessment of a borrower’s capacity to service the loan. However, this doesn’t apply to uninsured mortgages, but that’s now being considered by OSFI, including the implementation of graduated or tiered limits.
Existing OSFI guidance could be strengthened by introducing a lender-level volume restriction on loans with high debt service ratios. For such a measure to operate effectively, OSFI is considering:
"The formulas and definitions for GDS and TDS and whether to adopt those that currently exist for insured mortgages;
Appropriate GDS and TDS thresholds for uninsured mortgages, which could involve graduated or tiered limits; and,
An explicit amortization limit used for qualification in B-20 that, in combination with debt service ratio restrictions, would limit excessive leverage."
3. Interest rate affordability stress tests – The Minimum Qualifying Rate (MQR)** is currently applied in the GDS calculation at underwriting. OSFI maintains the MQR for uninsured mortgages, and the federal Minister of Finance maintains the MQR that applies to insured mortgages.
As such, OSFI is exploring design elements that could result in the adoption of more risk-sensitive tests of affordability, and could respond better to risks arising from high household indebtedness. Some of these design elements include:
"Creating an explicit principles-based expectation that lenders establish, monitor and report on different MQRs, in addition to the current MQR set in regulation, according to different risk characteristics and product types;
An expectation that the MQR be applied to a borrower’s total debt service (i.e., for other existing mortgages and non-mortgage debt obligations), in addition to gross debt service; and, similarly,
Tests of affordability and other debt serviceability measures for non-mortgage retail lending outside of B-20."
None of the proposed changes will be finalized until after OSFI’s consultation period, which is now open until April 14, 2023. At this time, we don't know how these potential changes will be in place.
Criticisms towards new proposals
While OSFI says the changes are required to counter record levels of household indebtedness, critics wonder if the announcement has more to do with optics in response to rising affordability challenges for borrowers struggling with high interest rates.
On January 10, 2023, the CEOs of Canada’s big banks said tens of thousands of Canadian borrowers could be vulnerable to defaulting on their mortgages as rates rise and homeowners struggle to make monthly payments.
The Scotia bank has about 20,000 borrowers that it considers “vulnerable"- Scotiabank’s CEO
While OSFI in 2023 thinks it’s time to discuss tightening mortgage lending rules, some fear it could drive more borrowers to non-federally regulated markets, such as private mortgages and Mortgage Investment Corporations (MICs).
In other words, this new proposals, if come into effect, can push more consumers into alternative lending or into private lending, which are higher-risk and higher-cost credit facilities anyway. However, it will be an opportunity for brokers to bring value to those who may get turned down by the banks.
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What is the Stress Test? Watch the video (English/ Persian)
* B-20 Guideline requires lenders to strictly evaluate a borrower’s ability to pay back a loan based on certain conditions. Guideline B20 also sets standards that improve banks’ resilience, both under normal conditions and during financial downturns. Lenders subject to OSFI supervision hold nearly 80% of all residential mortgages issued in Canada.
* * The MQR is a minimum interest rate that is applied in debt service coverage ratio calculations to test the borrower’s ability to afford higher debt payments in case of negative shocks to income, or increases in interest rates or expenses.