Canada's banking regulator considers alternative to mortgage stress test

  3/11/2025 |   SHARE
Posted in Home Buyers by Sandra Karas| Back to Main Blog Page

Canada’s top banking regulator is considering a new approach to mortgage risk management that could replace the current stress test with stricter rules on how much banks can lend to high-risk borrowers.

The Office of the Superintendent of Financial Institutions (OSFI) is evaluating whether to shift responsibility from borrowers to lenders, meaning banks, rather than individuals, would face tighter restrictions on issuing high-risk mortgages.

A final decision is expected after a full year of assessment, according to a November 6 memo from OSFI Superintendent Peter Routledge.

“If the test functions as expected, we anticipate it could serve as an alternative or complement to the minimum qualifying rate,” Routledge wrote, referring to a new loan-to-income ratio cap that took effect earlier this year.

“We’ll ensure any adjustments are done correctly after thorough testing.”

Currently, Canada’s mortgage stress test requires uninsured borrowers to qualify at an interest rate of 5.25% or their contract rate plus 2%, whichever is higher. The rule is meant to ensure homeowners can still afford their payments if interest rates rise.

In October 2024, OSFI relaxed the stress test for borrowers switching lenders, allowing them to bypass it as long as they don’t change their loan amount, amortization period, or other key terms.

Now, OSFI is considering whether a different approach, one that limits how much banks can lend to highly indebted borrowers, could be more effective than stress-testing individual homebuyers.

The new system would focus on a borrower’s total debt compared to income rather than requiring them to qualify at a hypothetical higher interest rate.

OSFI’s internal analysis found that the stress test wasn’t stopping borrowers from taking on massive debt loads. In fact, many borrowers were still securing mortgages that exceeded 450% of their household income.

“Our analysis found that the minimum qualifying rate did not prevent a substantial accumulation of mortgages with extremely high loan-to-income ratios, exceeding 450%,” the memo noted. “The loan-to-income test evaluates lenders’ portfolios rather than imposing a requirement on individual borrowers.”

To tackle this, OSFI introduced a loan-to-income (LTI) cap on January 31, 2025, limiting federally regulated lenders from issuing more than 15% of their quarterly mortgage originations to borrowers whose mortgage debt exceeds 450% of their annual income.

The regulator is now assessing whether this portfolio-level cap on risky lending could fully replace the mortgage stress test.

A final decision will be made after year-end, OSFI said.

While borrowers have long criticized the stress test for limiting affordability, OSFI has repeatedly warned that removing it without an alternative would expose the banking system to major risks.

Read more: Has the mortgage stress test served its purpose?

Canada’s housing market has a history of downturns tied to weak lending rules. The 1982 housing crash led to the collapse of 36 federally insured loan and trust companies, along with two banks (Canadian Commercial Bank and Northland Bank of Alberta) which required $1.3 billion in government deposit insurance payouts.

Former CMHC CEO Romy Bowers has also stressed the importance of preparing for worst-case scenarios. In 2017, she testified that CMHC stress-tests its insurance portfolio against a 30% national home price drop and an 11.5% unemployment rate, conditions not seen since the early 1980s recession.

"I reference a 30% national house price decline," Bowers said. "Canada has never experienced such a downturn – knock on wood – but we must prepare for potential risks."

Source: Canadian Mortgage Professional

Canada Living, First Time Home Buyers, Home Buyers, Mortgage Consumers, OSFI