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Canada’s banking regulator says it has no plans to remove the stress test on uninsured mortgages for borrowers who choose to switch lenders.

The Office of the Superintendent of Financial Institutions (OSFI) made the statement to CMT in response to recommendations released by the Competition Bureau on Thursday, which included advocating for the removal of this stress test requirement.

The current regulation exempts borrowers with default-insured mortgages—typically those who have made a down payment of less than 20%—from needing to undergo the stress test when switching lenders. OSFI explains that insured mortgages present a lower risk to financial institutions since the credit risk is assumed by default insurers, not the lenders themselves.

“When an uninsured borrower switches lenders, the new lender takes on the credit risk of that mortgage loan,” an OSFI spokesperson told CMT. “That lender needs to assess the risk in the context of their own risk appetite.”

But in its public submission on strengthening competition across Canada’s financial sector, the Competition Bureau criticized the rule, saying policymakers should focus on promoting the practice of switching lenders rather than discouraging it.

“The benefits for borrowers to shop around and switch mortgage lenders is well known,” the Bureau’s report says. “The expectation to conduct the same stress test again at the time of renewing uninsured mortgages risks harming borrowers and the competitive process.”

What is the mortgage stress test? The mortgage stress test for uninsured mortgages—those with a down payment of more than 20%—is overseen by OSFI. Borrowers must qualify at the higher of the Minimum Qualifying Rate (currently 5.25%), or two percentage points above their contract rate, whichever is higher. In today’s high rate environment, practically all mortgages are being qualified at the latter.

Timely recommendation amid wave of upcoming renewals

According to the Canada Mortgage and Housing Corporation (CMHC), around 2.2 million mortgages are facing higher payment when their terms come up for renewal in 2024 and 2025.

To ease the burden, the Bureau believes many mortgage holders will consider switching lenders rather than stay with their current provider, and the current rules get in the way. By the CMHC’s estimation, around 73% of all mortgages by mid-2023 were uninsured.

In the Bureau’s view, borrowers present the same risk to lenders regardless of whether or not they switch providers while renewing: they have the same income, seek the same mortgage, and own the same property.

“In fact,” the Bureau says, “switching, or the credible threat of switching, may actually lower the risk of a borrower’s ability to repay their mortgage to the extent it results in lower interest rates or other more preferential financial terms.”

Jill Moellering, an Edmonton-based mortgage planner at Mortgage Architects, says removing the stress test for existing uninsured mortgages would give clients more freedom given how the current rules encourage them to remain with their existing lender.

She also believes such a change would provide payment relief to borrowers with mortgages coming up for renewal, especially those coming out of low fixed rates of around 2% into current rates of 5%.

But she isn’t sure that removing the stress test on switches would improve housing affordability concerns overall, one of the arguments routinely made by critics of the stress test.

Moellering says she doesn’t believe it would be “sufficient enough to curb the overall housing affordability concerns driven by increasing demand and supply issues paired with the higher rate environment.”

Frustrating news for the mortgage industry

OSFI’s decision to stand firm on its policy is disappointing for mortgage professionals who were hopeful for a change in the wake of the Competition Bureau’s recommendation.

David Larock, a mortgage broker with Integrated Mortgage Planners in Toronto, says the stress test policy as it currently exists “traps the most marginal and vulnerable borrowers at their incumbent lenders.”

Larock also doesn’t buy OSFI’s argument that borrowers renewing with the same lender are less risky, since they’ve already been through the due diligence process.

If a lender approves a client for a 5-year term, he points out, a client that renews with the same lender is being re-approved based on information that is five years out of date, unless they’ve also gotten an appraisal.

Meanwhile, someone switching to a different lender has to jump through the stress test hoop once again with information that might be just as outdated as someone who stays. “That is the part that makes no sense,” Larock says.

Ultimately, Larock thinks the Competition Bureau’s recommendations may help convince OSFI to reexamine its policy, but he thinks more pressure is needed.

“I hope that when the regulators and the politicians get in a room and they have a conversation, they get asked these tough questions,” he says. “Because I’m not satisfied with any of the answers, and I don’t think the public should be either.”

Source: Canadian Mortgage Trends