Canadian Banks Begin Circumventing Mortgage Stress Test For High-Income Clients

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A new mortgage stress test? Don’t bother me with those peasant details. After Canada’s property bubble attracted global criticism, they announced tighter mortgage lending. On April 8, the Office of the Superintendent of Financial Institutions (OSFI) said they would make the stress test harder. By the following Monday, the first bank launched a pilot mortgage program to increase the maximum mortgage size. They just didn’t do it publicly.

Uninsured Mortgage Stress Test

The OSFI B-20 Guideline, a.k.a. the stress test, checks a borrower’s income against higher rates. Instead of checking if a borrower can afford a mortgage at a contract rate, they see if they can pay a much higher one. They use the contract plus 2 points, or the Bank of Canada’s benchmark rate. This reduces the maximum mortgage a household can borrow, ideally lowering risk.

The idea is to allow borrowers to enjoy the benefits of lower interest rates, without spending more. Often when rates are lowered during a hot market, home prices just absorb the slack. If tested at a higher rate, the borrower gets the benefits of cheap debt, without spending more. It also ensures they can afford the payments, and the economy doesn’t give more points of spending to housing. It’s an all-around win for the most part.

OSFI Tightens Stress Test By Raising The Floor

Just a few days ago, OSFI said they would be increasing the rate of the stress test to further reduce buying power. The benchmark rate used as a floor in calculations increased from 4.79% to 5.25%. This reduces the max borrowing power using the benchmark by 4.5%, compared to the current level. Theoretically, of course.

Typically the maximum mortgage a household can service is calculated using debt service ratios. There are two ratios — the gross debt service (GDS) and total debt service (TDS).  A borrower’s monthly payments need to be lower than both of these ratios.

The GDS is the maximum income that can be used to pay for a mortgage. This includes the principal, interest, taxes, and heat (PITH). If you’re buying a condo, you also need to typically add half your maintenance fees as well. Most lenders cap the GDS at 35% of income, meaning payments need to be under this level.

The TDS is the maximum income that can be used to pay for PITH, and other debt servicing costs you might have. This includes your GDS costs, as well as all of your other monthly debt servicing costs. Car payments, credit cards, that Thigh Master you financed for the past 30 years, etc. These are included in this number, to make sure you aren’t pushed to the brink. Most lenders cap this number at 42% of income, and all debt needs to be lower. If your other payments are more than the difference between the GDS and TDS, you lose a little room from your max GDS.  

Scotiabank Launches Pilot Mortgage Program For High-Income Borrowers

Scotiabank is the first bank to launch a pilot to increase leverage post-update. As of April 12, 2021, the bank has launched a hush-hush pilot program that raises the TDS to 50%, with no specified GDS. An agent explained this means they’ll approve the GDS on a case-by-case basis, up to the TDS. As long as it fits within the risk profile for the lender.

Borrowers in the pilot wouldn’t see their leverage drop 4.5% from today’s levels, after the stress test increase. Pilot participants actually see their budgets increase by up to 40% from before the OSFI announcement. Lending standards are loosening for some, while tightening for others. 

Pilot For High-Income Borrowers In BC, Ontario, And Quebec

The pilot is for branches in B.C., Ontario, and Quebec, and applies to ideal mortgage borrowers. The application’s uninsured bureau risk indicator (BRI) must be A-rated. There can only be two borrowers on the application, and their combined income needs to be over $120,000 per year. The automated system will pre-determine if the borrower fits these low-risk criteria. 

Don’t bother looking for the details of the program on their website. The program is conducted in the strangest way I’ve ever witnessed. Customer service wouldn’t acknowledge its existence by phone. Only hinting if the branch said it existed, it definitely does exist. I could almost hear the wink through the phone.

Even more weird was the response from headquarters. They’ve answered almost every question we’ve ever had. Except for this one. The bank declined to comment when asked to confirm the details obtained from a branch. Multiple branches confirmed the details, so it’s unclear why they wouldn’t. It’s weird when getting the details of a mortgage program from a bank feels like trying to score Molly, but here we are. Life in a property bubble.

OSFI Does Not Dictate Debt Service Levels, But Is Monitoring Them

OSFI confirmed Guideline B-20 allows federally regulated financial institutions (FRFIs) to adjust the TDS. The Guideline doesn’t dictate a limit. However, they are monitoring the debt service levels for risk. The regulator expects FRFIs to take extra measures to manage any additional risk they may take on. 

Is this more risky lending? Not really. A lot would need to happen to an uninsured mortgage borrower for the bank to lose. Prices would need to drop more than their substantial downpayment of more than 20%. Mortgage rates would have to more than double, to make it more difficult to carry on the same income. The borrower would also have to not pay their bill for an extended period of time as well. Honestly, the risk is pretty low for the lenders. Personally, it would be surprising to not see other banks roll out similar programs once they find out.

The pilot program does bring into question whether a higher stress test makes sense though. While it lowers leverage for some, the rules don’t apply to everyone. In cities like Toronto and Vancouver, a borrower’s income would have to clear the pilot’s hurdle for even the cheapest homes on sale now.

The only differentiating factor would be credit quality. As we learned during the US housing crisis, high credit scores didn’t actually change the outcome. Investors with high credit scores were the demographic to show the largest growth in defaults. It turns out using precedent to determine how someone acts during an unprecedented situation, isn’t all that helpful.

source: (Better Dwelling)