Proposed changes to mortgage rules could spur pre-approval ‘panic’

As Canada’s banking regulator considers tighter rules for mortgage lending, a “panic” could be coming as some borrowers rush to get into the housing market before it becomes even more difficult.

The Office of the Superintendent of Financial Institutions (OSFI) unveiled a consultation last week with three proposals aimed at ensuring borrowers actually have the money to cover the debt they take on — and restricting Canada’s banks from lending to those on the margins.

Consumer debt has increased dramatically in recent years, said OSFI, warning that could bring risks to the finances of federally regulated banks, which hold about 80 per cent of all residential mortgages.

The consultation is open until April 14 and any changes are unlikely to take effect until later in the year, but mortgage brokers expect some clients to make a move before then.

“I think this news from OSFI will create a bit of a panic in the market where buyers that are sitting on the sidelines are probably going to be moving forward a little quicker than they anticipated,” said Victor Tran, a mortgage broker and real estate expert for rate comparison website RATESDOTCA. “I can see a rush before the spring market.”

That’s because the tweaks to the bank financing rules could force some borrowers to put down larger down payments, reduce the size of the mortgage for which they qualify, or push them toward non-bank lenders that charge higher interest rates and offer shorter-term loans.

Anthony Venuto, a broker at InTouch Mortgage Solutions in Vaughan, said it will be crucial to watch the fine print around any announcement OSFI makes after the consultation wraps up.

“If in April, they (OSFI) come out and say, ‘These are the rules, they’re going to come into effect in June, July or August,’ you’re probably going to see a mad dash for pre-approvals,” Venuto said.

On top of the timing of the rules, he said, there will also be questions about issues such as whether borrowers who made pre-construction purchases will be grandfathered in under the existing rules.

“These are all going to be factors that will determine how quickly people are going to run into their brokers and run into their banks and get pre-approvals for 120 days just to see if they can close before these rules come into effect.”

OSFI is seeking input on three measures that could affect borrowers’ ability to service their debt obligations. One focus is on limits on either mortgage debt relative to borrowers’ total income or on overall indebtedness relative to income.

The banking regulator said that a loan-to-income (LTI) ratio of 450 per cent or more is “high” and it’s considering limiting new loan originations that exceed that threshold to no more than 25 per cent per quarter.

OSFI is concerned because high LTI loan originations have accounted for an industry-wide average of 34 per cent since the pandemic, up from a pre-pandemic average of 24 per cent.

The regulator is also looking at making changes to the mortgage stress test and considering limits on debt service obligations (e.g. monthly payments of principal and interest) as a percentage of borrowers’ income.

Jaeme Gloyn and Julia Gul, analysts with National Bank of Canada, said the changes could affect at least five to 10 per cent of borrowers “if and when implemented.” They noted that some smaller lenders, which tend to have a higher proportion of high LTI loans, could be hit harder than the Big Six banks.

Sid Rajeev, head of research at Fundamental Research Corp., said the biggest change would be limits on high LTI mortgages, which he also estimated could affect about 10 per cent of borrowers.

“That would directly reduce demand and housing prices again,” Rajeev said, adding it could benefit the alternative lending market, particularly mortgage investment corporations (MICs), which are less regulated than the banks.

MICs — which currently charge interest rates of between about six to 13 per cent compared to about five or six per cent at banks, he said — are often an option for borrowers with poor credit or other complications in their lending history that prevent them from securing bank loans.

“More and more borrowers should approach the sector this year,” Rajeev said, noting that MICs already saw a significant increase in growth last year as interest rates began to rise quickly.

There are about 200 MICs with about $15 billion in assets under management, a number that represents less than one per cent of the overall residential market, Rajeev said.

John Shmuel, managing editor of RATESDOTCA, said many mortgage brokers he’s spoken with believe the proposals themselves make sense. However, they question why OSFI didn’t do this sooner, particularly amid the “froth and excitement” of the market in 2021 and early last year.

“The question is why now? We are in a downturn, we don’t know how long the downturn is going to be, lending has slowed significantly and there’s the risk that this accelerates an ongoing downturn,” Shmuel said. “So, to tighten lending at a time when lending is already slow brings with it a lot of additional risks.”

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