Office of the Superintendent of Financial Institutions
In early 2020, OSFI initiated a consultation process on the benchmark for the qualifying rate for uninsured mortgages contained in OSFI Guideline B-20 — Residential Mortgage Underwriting Practices and Procedures. OSFI suspended its consultation in March 2020 due to the COVID-19 pandemic. The purpose of this letter is to relaunch OSFI’s policy work on the qualifying rate with a new proposal and to reinforce the principles of sound mortgage underwriting in Guideline B-20 in light of the current economic environment.
The COVID-19 pandemic has created economic uncertainty. Since the pandemic began, risks related to the housing market have grown for Canadian federally regulated financial institutions (FRFIs). Interest rates have declined to record low levels, although they could rebound once economic conditions stabilize. Low interest rates have contributed to the conditions for elevated house prices across Canada. In addition, while Canadians have gained significant savings throughout the pandemic, high levels of household indebtedness remain.
These factors, temporary or prolonged, contribute to FRFI vulnerabilities, which could generate significant loan losses if economic conditions deteriorate. FRFIs can experience losses both through the potential inability of borrowers to meet their debt obligations, as well as through declining values of the real estate properties pledged as collateral in mortgage loans.
Currently, Guideline B-20 establishes that the qualifying rate for uninsured mortgages (i.e., those with a down payment of greater than 20 percent) should be the greater of the mortgage contractual rate plus 200 basis points or the Bank of Canada five-year benchmark rate. This benchmark rate serves as a minimum qualifying rate (or “floor”) in a low interest rate environment.
As in early 2020, OSFI remains concerned with the current benchmark (based on the mode of the posted rates of the large Canadian banks), which is neither dynamic nor representative of the entire market. In early feedback to OSFI’s 2020 consultation, stakeholders expressed concern that, while dynamic, the previously proposed benchmark (based on the median rate of all insured mortgage contracts) would be highly volatile. This could create uncertainty among consumers in regards to their home purchase and financing decisions. The volatility of mortgage contract rates throughout the COVID-19 pandemic has further underscored this concern. Further, for uninsured mortgages, neither the current benchmark nor the previously proposed benchmark are risk-based.
Given these considerations, OSFI is now proposing to establish a fixed floor rather than relying on the current or previously proposed benchmark rate. The Superintendent would initially set the floor at 5.25 percent. This ensures that the financial system is adequately prepared for the possibility of a return to pre-pandemic economic conditions. The average benchmark rate that prevailed in the 12 months leading up to the pandemic was 5.25 percent.
The qualifying rate for all uninsured mortgages should be the greater of the mortgage contractual rate plus 200 basis points or 5.25 percent.
OSFI invites interested stakeholders to provide comments on the revised proposal by email at firstname.lastname@example.org by Friday, May 7, 2021.
OSFI will revisit the calibration of the qualifying rate periodically to ensure it remains appropriate for the risks in the environment. Moving forward, this review will occur at a minimum annually, every December, well in advance of the high-volume housing spring season. OSFI will publish the results of every review.
Given the current risk environment, OSFI will be looking for heightened vigilance from FRFI lenders in applying the principles of Guideline B-20 related to collateral management, income verification and debt servicing, combined Mortgage-HELOC loan plans and risk governance.
The COVID-19 pandemic has limited the ability of FRFI lenders to verify the accuracy and stability of property valuations. FRFI lenders should undertake comprehensive and prudent approaches to collateral valuations for higher-risk transactions. Under Guideline B-20, higher-risk transactions include loans with a relatively high LTV ratio and loans in markets that have experienced rapid property price increases.
The most secure mortgages are those to borrowers who have the capacity to repay the loan, and not those that accumulate equity through rapidly rising house prices. OSFI expects FRFI lenders to continue applying rigor in the verification of a borrower’s income, and prudence in the calculation of debt service ratios. Consistent with Guideline B-20, FRFI lenders should not rely on collateral values as a substitute for stable and verifiable income.
OSFI expects FRFI lenders to exercise prudence when qualifying borrowers for combined mortgage-HELOC loan plans. FRFI lenders should continue assessing principal and interest payments using conservative criteria (e.g., a shorter amortization period). Consistent with Guideline B-20, FRFI lenders should limit the aggregate re-advanceable components of a combined mortgage-HELOC loan plan to a maximum authorized loan-to-value (LTV) ratio of less than or equal to 65 percent.
OSFI expects FRFI lenders to revisit their Residential Mortgage Underwriting Policies (RMUP) to ensure current market conditions are considered. A stated risk appetite of a FRFI lender (as approved by its Board of Directors) should align with its actual mortgage underwriting and risk management practices.
OSFI assesses the safety and soundness of FRFIs and contributes to the stability of the financial system. Consistent with this mandate, OSFI will continue to monitor the Canadian housing market, the impacts of the COVID-19 pandemic on market dynamics, as well as FRFI lender practices, particularly in the areas of collateral management, income verification, debt servicing, combined mortgage-HELOC loan plans and risk governance.
OSFI will communicate final amendments and its intended approach to the qualifying rate for uninsured mortgages in Guideline B-20 by May 24, 2021, with a coming into force date of June 1, 2021.
Following the implementation of a revised qualifying rate, OSFI will closely monitor FRFI lenders to ensure that they do not weaken their underwriting criteria, such as extending amortization periods or increasing debt service limits, in order to circumvent the qualifying rate for borrowers.
Further, OSFI is already enhancing its supervisory scrutiny of FRFI lenders, in general, by conducting a comprehensive review to ensure that the practices of FRFI lenders are consistent with OSFI’s expectations regarding prudent mortgage underwriting. OSFI will continue to be proactive with FRFI lenders if it identifies areas requiring attention.