Canada Imposes Tougher Mortgage Rules Effective 2018 -- 2nd Update

By Paul Vieira and Vipal Monga Features Dow Jones Newswires

Canada's banking watchdog unveiled tougher mortgage-financing rules that take effect on Jan. 1 that real estate watchers and economists say could dramatically slow house buying and borrowing.

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The measures were first proposed in July, amid heightened concern over rapid house-price appreciation in the greater Toronto area, Canada's largest urban center, and surrounding communities in southern Ontario. Since the proposal, the Bank of Canada raised its benchmark interest rate twice, and Governor Stephen Poloz said in July concerns over financial stability played a role in the policy-decision making process.

The Office of the Superintendent of Financial Institutions confirmed Tuesday the measures they proposed will kick in, and real estate watchers say the regulator has crafted tougher rules than originally envisaged.

The most notable measure is a provision that would require all prospective buyers -- even those with a down payment of over 20% -- to undergo a so-called stress test before a bank can issue a loan. Previously, only buyers with a down payment of less than 20% had to undergo a stress test. Under the stress test, prospective buyers would have to qualify for a mortgage at a rate at whichever is greater: either 2 percentage points above the negotiated rate, or the Bank of Canada's five-year benchmark rate. The central bank's five-year rate stands at 4.89%. The regulator originally proposed the test just cover two percentages point above the negotiated mortgage.

"These revisions reinforce a strong and prudent regulatory regime for residential mortgage underwriting in Canada," said Jeremy Rudin, head of the banking watchdog.

Robert McLister, founder of the Canadian mortgage-rate comparison site, said the new rules target the fastest-growing part of the mortgage market -- uninsured mortgages -- and could affect one out of every six prospective home buyers. In Canada, mortgage insurance is mandatory unless the buyer has a down payment of 20% and over.

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"This is easily the most groundshaking mortgage rule of all time, and that's not an understatement," Mr. McLister said in an interview.

Economists said the tougher mortgage regulations will further hit a softening housing market. Recent data from the Canadian Real Estate Association indicated unadjusted sales in September were 11% below year-ago levels, and price growth has slowed considerably, especially in the Toronto market after the introduction of a foreign-buyer's tax in southern Ontario.

"This will have a far greater impact on house prices than the Bank of Canada recent interest rate hikes," said David Madani, economist at forecasting firm Capital Economics. "Needless to say, these latest mortgage rule changes will have a negative impact on house prices and household wealth."

TD Bank's economics team said it anticipates the measures will depress housing demand by 5% to 10% once fully implemented.

Besides universal stress testing, Canada's banking regulator has also ordered lenders to require the loan-to-value ratio used in evaluating a mortgage "remain dynamic" and adjust for local market conditions, and prohibit co-lending arrangements that potentially circumvent existing regulations.

In its most recent assessment of the financial system, the Bank of Canada said more than 80% of new mortgage lending by Canada's big six banks in the Toronto and Vancouver areas covers uninsured mortgages.

One key reasons is that earlier this decade, the Canadian government opted to no longer backstop mortgage insurance on homes valued at 1 million Canadian dollars ($796,000) or greater.

In its review, the Bank of Canada said the proportion of highly indebted uninsured mortgage holders -- incorporating a loan-to-income ratio of over 450% -- rose to 17% last year from 12% in 2014.

Canada's large banks were circumspect in their reaction to the regulator's move. A spokeswoman for TD Bank said lenders and federal authorities are already aligned in pursuit of prudent lending standards. A Royal Bank of Canada official said the bank was already closely monitoring the housing market and household debt levels, and the lender's underwriting principles reflect current conditions.

The final version of the rules, which adhered closely to OSFI's draft in July, won't change the banks' earnings outlook this year, said Robert Sedran, an analyst for the Canadian Imperial Bank of Commerce, in a research note. "We are comfortable that the banks are in a favorable operating environment."

The new set of rules are likely to have a bigger impact on lenders that cater to borrowers with less-than-stellar credit ratings, said Jaeme Gloyn, analyst with National Bank of Canada. He said lenders such as Home Capital Group and Equitable Group Inc., could see earnings come in between 2% and 6% below 2018 estimates as a result of the change.

Write to Paul Vieira at and Vipal Monga at

(END) Dow Jones Newswires

October 17, 2017 16:16 ET (20:16 GMT)