Later next month, the Office of the Superintendent of Financial Institutions (OSFI) will no longer require financial institutions to subject borrowers to the stress test when renewing their mortgage with a new lender.
When borrowers initially take out a mortgage, they are required to pass a test that proves they can cover mortgage payments at an interest rate that is 2% higher — "stress," in other words — than their actual interest rate.
Once the mortgage is up for renewal, borrowers can renew their mortgage with the existing lender or switch to a different lender. If they choose the latter, however, they are currently required to undergo the stress test again, under the new financial environment, even if no changes are being made to the mortgage terms.
Borrowers with insured mortgages — those who make a down payment of less than 20% on the property they're purchasing must insure their mortgage — are currently exempt from the stress test if they decide to make a similar "straight" switch, however, so the change, which was first reported by the Globe and Mail, aligns the requirements for both.
The change has a direct benefit to borrowers by making mortgage renewals less stressful, but also has the indirect benefit of facilitating more competition among lenders.
In fact, the change was recommended by the Competition Bureau earlier this year when the Department of Finance was conducting consultations regarding how to strengthen competition in the financial sector, in conjunction with a recommendation to "adopt a consumer-driven banking framework" — i.e. "open banking."
Last month, the Competition Bureau reiterated the need for more competition and singled out the elimination of the stress test from mortgage renewals as a significant way to address this. The assumption is that under the current rules, borrowers are more inclined to renew with their existing lender, because they don't have to undergo the stress test.
"Many of our financial services markets are highly concentrated and have sticky customer bases," said the Competition Bureau. "If it were easier for consumers to switch providers, banks and other financial institutions would have to work harder to keep customers happy, meaning lower prices and higher quality services. Lower switching costs would also make these markets more contestable for new entrants and challengers. This would add competitive pressure."
The current rule "makes it difficult if not impossible for some homeowners to find a new lender and take advantage of cheaper interest rates." When a borrower can't switch to another lender, the existing lender essentially faces no competition, and can thus offer higher rates without fear of losing the borrower, the Competition Bureau said.
Statistics At A Glance
- 73% of all outstanding mortgages in Canada are accounted for by the big six banks (CMHC, 2023)
- 73% of all outstanding mortgages are uninsured (CMHC, 2023)
- 12.1% of mortgage renewers ultimately switch lenders (Bank of Canada, 2020)
"This is not just a theoretical concern," the Bureau added. "There is empirical evidence that borrowers pay more when remaining with their current lender. A Bank of Canada Staff Working Paper that examined the impact of the stress test found preliminary evidence of so-called 'invest-then-harvest' pricing behaviour. It particularly notes that 'Borrowers who renew their mortgage with their incumbent bank on average pay interest rates 6.1 basis points (bps) higher than new borrowers, and borrowers who switch banks at renewal on average pay 10.2 bps lower than those who stay."
Now is the time to act, the Competition Bureau adds, because approximately $600 billion worth of mortgages are expected to be up for renewal in the next two years, and an estimated 2.2 million mortgages — 45% of all outstanding mortgages — will be facing higher interest rates.
"With the current high interest rates, some borrowers may be unable to pass the stress test even though they have good credit and would have been able to service their loan. These borrowers will have to remain with their current mortgage provider, where they will not need to pass the stress test again."
The Competition Bureau notes that the stress test was implemented to protect both borrowers and lenders, and that this change will not create more risk for lenders.
"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 change that eliminates the stress test when renewing mortgages with a different lender is expected to come into effect on Thursday, November 21.
