In the current high-rate environment, many homeowners are desperately looking for cheaper rates when they renew their mortgage. Here’s the thing: Uninsured borrowers who stick with their current lender won’t face the mortgage stress test, but if they choose to switch to a new lender when their term ends, they must be stress-tested anew.
If this seems like a nonsensical double standard, that’s because it is. The truth is, there is zero rationale for applying the stress test in cases where all aspects of the mortgage – except for the lender – haven’t changed.
The Office of the Superintendent of Financial Institutions (OSFI) – the government agency that regulates federally incorporated lenders – created the stress test in 2018 so buyers had to prove they can manage rates well above what lenders are offering. All buyers must pass the stress test when they first get a mortgage, whether they are insured – which means they had less than a 20-per-cent down payment – or were able to buy uninsured.
But the two groups are treated differently when it comes time to renew – if they choose a new lender. This issue of re-stress testing on renewal has been a point of contention within the mortgage industry since the rules were introduced. The criticism is that they are anti-competitive, dissuading borrowers from seeking out better rates upon renewal, and removing the incentive for lenders to offer attractive options to existing clients.
OSFI’s reasoning is that all borrowers should be stress tested any time a new mortgage is taken out, since it requires new underwriting. But discouraging switches has a real, material impact: borrowers who stick with their incumbent bank pay on average 6.1 basis points more than a new customer. Meanwhile, those who make a switch will pay 10.2 basis points less than those who stay … if they can stomach that stress-test hurdle.
Last October, OSFI clarified lenders don’t need to stress test switching insured borrowers – those who put less than 20 per cent down on their home purchase – as long as their original mortgage amount and amortization period remains the same.
OSFI’s main argument here is that insured borrowers come with a layer of built-in default protection courtesy of the Canada Mortgage and Housing Corporation (CMHC). This means they pose less of a risk than their low-ratio uninsured counterparts, whom the lender is fully on the hook for should they not make their payments.
However, recent analysis by Canada’s Competition Bureau found this stance holds little water. On March 21, the Competition Bureau recommended the stress test be dropped for uninsured borrowers looking to make a “straight switch” to a new lender at renewal time.
“It is important to emphasize that these borrowers present the same risk in either case, they have the same income and are seeking the same mortgage on the same house. In fact, switching, or the credible threat of switching, may actually lower the risk of a borrower’s inability to repay their mortgage to the extent it results in lower interest rates or other more preferential financial terms,” the Competition Bureau said in its submission.
OSFI, however, rejected the recommendation, which means the two-tiered system will remain for the foreseeable future, subjecting uninsured borrowers seeking a better deal to another round of income and debt scrutiny – despite proof that they can successfully carry their mortgages.
Now, this isn’t a knock against the mortgage stress test as a whole. The stress test – which requires borrowers to prove they can carry their loans at 2 per cent higher than the rate they are actually getting from their lender – has proven logical, especially during the recent cycle where the Bank of Canada has hiked rates aggressively to fight inflation. Despite the pain higher rates has caused borrowers, Canadian mortgage defaults remain very low – and we have the stress test, in part, to thank for that.
However, clients who are renewing – whether or not they’re insured – are generally solid borrowers. These are mortgage holders who have already passed the stress test and now have a successful payment history, along with built-up equity. When you consider they’re also likely to get a lower mortgage rate by switching, that would decrease their risk profile even further.
In today’s pricey interest-rate environment, no one can afford a double standard. It’s time, instead, to put one in place that actually reflects the true risk of renewing borrowers by either stress testing all or none – but moving to a new lender should not be the deciding factor.
James Laird is the co-founder of Ratehub.ca and president of CanWise Financial mortgage lender. Penelope Graham is the Director of Content at Ratehub.ca.