*This post was created in collaboration with Mortgage Maestro.
It’s tough to get approved for a mortgage these days, especially with rising interest rates and sky-high housing prices. It might even start to get tougher.
Mortgage affordability has been a major issue for borrowers for years. Especially since the mortgage stress test rules were put in place a few years ago.
Now proposed changes by the Office of the Superintendent of Financial Institutions (OSFI) could make it even more difficult to secure a mortgage. Which could turn would-be home buyers into long-term renters.
Let’s take a closer look at what these proposed OSFI changes are, and how they can impact your ability to buy a house in 2023.
What Are The Proposed OSFI Changes?
The OSFI recently proposed new changes to rules designed to reduce leverage and hedge against the risk of high indebtedness. The following are the proposals the OSFI is currently seeking feedback on that will impact both lenders and borrowers.
Loan-To-Income (LTI) And Debt-To-Income (DTI) Limits
The OSFI is considering adding a restriction to the LTI and DTI ratios. This would restrict the mortgage debt or total indebtedness as a percentage (or multiple) of the borrower’s income.
The proposed restriction will also limit the volume of loans a lender can provide at a certain debt threshold.
When you apply for a mortgage, lenders will compare your current income relative to the amount of debt you carry. This is also known as your debt-to-income (DTI) ratio.
A higher DTI means more of your income is dedicated to paying off current debt, leaving little left over for new debt. In this case, you’d be considered more of a risk to a lender. And you may have a tougher time getting approved for a mortgage.
While federally-regulated lenders don’t have required limits on DTI ratios, lenders typically cap DTI ratios around 36% to 45%. That means your total debts should be no more than 36% to 45% of your gross income. This amount may vary depending on your credit strength.
Lenders will also look at your total indebtedness as a percentage or multiple of your income. This is also known as your loan-to-income (LTI) ratio. For instance, an LTI ratio of 300% means your outstanding loan is 3 times your income.
According to the OSFI, you are considered overleveraged if your mortgage has an LTI ratio of 450% (4 times your income). If you exceed this threshold, you’re at higher risk of defaulting on your mortgage if there are any changes to your income or loan.
To reduce these risks, the OSFI is proposing limits that would restrict the volume of loans lenders can carry at a certain debt limit. As such, borrowers will be required to limit their total leverage when applying for a mortgage.
Debt Service Coverage Restrictions
A second OSFI proposal would restrict ongoing debt service obligations as a share of a mortgage applicant’s income. The debt service includes the principal and interest portions of mortgage payments, as well as any other related costs. Like the DTI and LTI restrictions, the limitations on debt service obligations would directly regulate lenders.
Lenders are currently required to measure limits on a borrower’s Gross Debt Service (GDS) and Total Debt Service (TDS) on insured home loans. Insured homes are mortgages with down payments of less than 20%. The GDS is the share of monthly household income that goes toward housing costs and must not exceed 39%. The TDS is the share of monthly household income that goes toward housing costs, plus all other debts, and must not exceed 44%.
Under the new proposals, OSFI suggests applying the GDS and TDS measurements to uninsured mortgages as well as insured home loans, including the introduction of tiered limits. The federal agency also said it is considering capping lenders’ volume of loans with high debt-service ratios.
Interest Rate Affordability Mortgage Stress Tests
In 2018, the federal government introduced the mortgage stress test as a way to reduce strain on the financial system. As well as ensure that borrowers would be able to cover mortgage payments even if interest rates increased. That means when applying for a mortgage, you have to qualify at today’s mortgage rate plus a higher rate in case rates rise throughout your mortgage term or when your loan is up for renewal.
Mortgage providers use the rules of the mortgage stress test to determine whether applicants can qualify for a loan and how much they can borrow.
Current Stress Test Rules
The most recent rules involve a mortgage qualifying rate for all mortgage applications, including uninsured and insured loans. For applications submitted on or after June 1, 2021, borrowers have to qualify for either:
- the benchmark rate of 5.25% or;
- the lender’s rate, plus 2%, whichever of the two is higher
For instance, if your lender offers you a rate of 3.15%, the 5.25% qualifying rate would apply in your stress test since the benchmark rate is the higher of the two. But if your lender offers a rate of 3.99%, you would have to qualify using a rate of 5.99% (3.99% + 2%), since this would be higher than the benchmark rate.
Proposed Stress Test Rule
Under the third OSFI proposal, the mortgage stress test would become even more stringent and require applicants to qualify at a higher minimum qualifying rate. Lenders could need to carry out a variety of minimum qualifying rates based on multiple risk factors and mortgage products.
Can You Qualify For A Mortgage With The OSFI Changes?
As mentioned, getting qualified for a mortgage with a conventional lender can be challenging, given the strong credit health and income required to get approved. Luckily, alternative lenders make it easier to secure a mortgage without all the hurdles you’d typically face in the traditional lending world.
With the recent proposals from the OSFI, borrowers may also find the services of mortgage brokers even more useful. Although the rule changes will predominantly impact CMHC-approved lenders, mortgage brokers such as Mortage Maestro have a network of mortgage lenders not affected by the changes.
Anyone turned down for a mortgage by a conventional lender may find that mortgage brokers can help connect borrowers with lenders that can serve them, regardless of what their credit score may be.
How Will The OSFI Changes Affect Your Mortgage Affordability?
The changes proposed by the OSFI can significantly impact lenders, borrowers, and the overall housing market in the following ways.
Lower Amounts Of Borrowers Will Qualify
With the new OFSI rules on DTIs and LTIs, fewer borrowers will be able to qualify. With more stringent mortgage stress test rules, you may have to reduce the loan amount you apply for in order to get approved for a mortgage. That also means you may have to look at less expensive homes when you’re out house hunting.
Ultimately, this can reduce your purchasing power. Similarly, higher interest rates make it more difficult to qualify for a higher loan amount. When interest costs increase, your monthly mortgage payment goes up, too.
Home Prices May Be Pushed Downward
Mortgage interest rates spiked throughout 2022, increasing the financial burden on homeowners and buyers. The Bank of Canada ended 2022 with yet another interest rate increase, causing many mortgage holders to pay hundreds of dollars more per month on their mortgage payments following a slew of rate hikes throughout the year.
As a result of reduced housing affordability, home prices across many real estate markets in Canada dropped. According to the Canadian Real Estate Association (CREA), the national home price average plummeted from $711,579 in December 2021 to $626,318 by December 2022, marking a year-over-year decline of 12.0%. Given the recent OSFI proposals, more hurdles for borrowers to secure mortgages could push home prices down even more in 2023.
More People Will Turn To Alternative Lenders
Getting approved for a mortgage with a traditional lender, like a bank or credit union, is difficult enough. Borrowers require good to excellent credit, a strong income, and manageable debt in order to qualify. But with the newly proposed OSFI rules, would-be homebuyers will likely have an even tougher time securing a home loan.
As such, we may be seeing a larger influx of borrowers entering the alternative lending sphere. Unlike traditional financial institutions, OSFI does not affect private lenders, only Schedule A banks.
Online lenders have much more flexible lending criteria, making it easier for borrowers to secure mortgages and other loan types. In exchange for lower credit score requirements, however, alternative lenders charge higher interest rates to mitigate risk.
When Do The OSFI Changes Start?
Right now, the OSFI is seeking feedback for the proposed changes. The consultation period doesn’t end until April 14, 2023. While an exact date for finalizing any changes is not yet determined, it’s possible that they could take place during the second half of 2023.
The new rules that the OSFI is proposing may be introduced to prevent borrowers from overleveraging themselves and the risks associated with that. But they also make homeownership more difficult to attain.
If you’re having trouble accessing a mortgage to buy a home from a conventional lender, consider looking to alternative lenders. Just be careful not to overburden yourself with a mortgage your budget can’t handle.