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Mortgage Financing Stress Test Makes the Grade

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Worrisome harbingers of borrower instability have faded somewhat since a mortgage financing stress test went into effect, Canada’s financial monitor reports. A recent analysis from the Office of the Superintendent of Financial Institutions (OSFI) cites a narrowing loan-to-value ratio in some particularly hot housing markets, like Vancouver, as evidence that new rules for underwriting residential mortgages are starting to have the intended effect.

“The revisions were necessary after OSFI identified potential risk and vulnerabilities caused by high household indebtedness and imbalances in some real estate markets that, left unchecked, could add greater risk to financial institutions and possible disruptions to the financial system,” a report in the OSFI newsletterstates. “Key revisions included measures to ensure financial institutions apply greater rigour in income verification and increased vigilance when assessing a borrower’s ability to repay their mortgages.”

Since January 2018, borrowers must prove they can manage a rise in interest rates equivalent to the greater of the Bank of Canada’s five-year benchmark rate or two per cent above their contracted rate. Lenders have new requirements for risk assessment in determining the portion of the home’s value the loan will cover.

“Improvements are evident in the quality of new mortgage loans, including higher average credit scores and lower average loan-to-value at mortgage origination,” OSFI observes. “There are indications that fewer mortgages are being approved for highly indebted or over-leveraged individuals.”

Among the continuing concerns, the report notes some lenders are still relying on the equity of the property, rather than the borrower’s ability to repay the loan, when approving mortgages. “OSFI will be taking steps to ensure this sort of equity lending ceases,” the report reiterates.

The Appraisal Institute of Canada (AIC) commends that pledge. “The guidelines require lenders to utilize appropriate numbers of on-site inspections and third-party professional appraisals to verify the value of collateral. On-site appraisals help to mitigate risk for both the lender and borrower in cases where there is a high loan-to-value ratio, when markets are in flux, or when the creditworthiness of the borrower may be lacking,” maintains, Peter McLean, the AIC’s president.

Thus far, there is little sign of predicted negative fallout from the mortgage financing stress test. Federal regulated mortgages represented almost the same share of all residential mortgages issued between July 1, 2017 and June 30, 2018 as in the previous 12 month period — falling by just 20 basis points to 76.7 per cent from 76.9 per cent — suggesting there has been no mass uptake of alternative options. Meanwhile, rates for renewals and new mortgages have remained on par, despite fears that borrowers would face higher rates upon renewal and have more limited ability to switch to another lender.

“The proportion of uninsured mortgages with amortization periods greater than 25 years has decreased from 51 per cent to 47 per cent over the same April to July period, suggesting that lenders are not extending amortization periods to allow borrowers to meet stress tests requirements,” OSFI concludes.