As 2017 wound to a close, the Canadian mortgage market appeared to be in good shape. Housing resales experienced 5 consecutive months of growth, with prices up 9.1% year-on-year according to the Canadian Real Estate Association. This included strong growth in Toronto, which had experienced a slump over the summer on the back of Government attempts to include speculation.
However, 2018 is already looking to be significantly more challenging, both for current mortgage borrowers and those seeking to enter the market. On January 1st, new lending criteria from the Office of the Superintendent of Financial Institutions (OSFI) came into effect which tightened the lending criteria banks use to assess potential borrowers’ ability to repay their loans.
Under the new rules, all borrowers will now be subject to a lending stress test, which previously only applied to borrowers with deposits of <20% that required mortgage insurance. Furthermore, the ability of the borrower to repay is now tested against either the Bank of Canada’s 5-year benchmark rate (5.14% at the time of writing) or their contract mortgage rate plus 200 basis points – whichever is higher. According to Bank of Canada (BOC) predictions in November, up to 10% of prospective borrowers may be disqualified under the tighter rules. According to RateSpy.com founder Rob McLister, “[the] OSFI hasn’t just tapped the brakes, it’s jumped on the brakes with both feet.”
"According to Bank of Canada (BOC) predictions in November, up to 10% of prospective borrowers may be disqualified under the tighter rules. According to RateSpy.com founder Rob McLister, “[the] OSFI hasn’t just tapped the brakes, it’s jumped on the brakes with both feet.”
Compounding the effects of these tighter rules are rising interest rates. The BOC raised the benchmark rate to 1.25% in January, the highest rate since 2009, and this increase was quickly passed on to the mortgage customers of the ‘Big 5’ banks. Many analysts predict further rate hikes over the coming 12 months if economic indicators continue to improve, although uncertainty around the future of the North American Free Trade Agreement may delay further rate increases. As well as affecting current borrowers, higher rates will make it more difficult for potential borrowers to enter the market, particularly in conjunction with the stricter stress testing criteria.
"More millennials would prefer to apply for a mortgage through digital channels than via a branch, and CUs will need a strong digital presence if they hope to successfully attract these younger customers."
However, every dark cloud has a silver lining, and in this case, there is a significant opportunity for Canada’s Credit Union (CU) sector. Many CUs are regulated at a provincial level, which means that they fall outside of the OSFIs jurisdiction and are therefore not bound by the harsher stress test rules. For potential borrowers who no longer meet the stricter stress testing criteria, CUs may prove to be an attractive alternative - particularly for younger customers entering the housing market for the first time.
Data from RFi Group’s Canada Priority and Retail Banking Council suggests that mortgages may be a potent tool for banks to draw millennials away from their traditional family banking relationships; when asked why they considered a bank to be their main financial institution, millennials were significantly more likely to say that it was the bank their family had always banked with – except for those that had taken out a mortgage in the past 12 months, where the impact of this family relationship was almost non-existent.
By leveraging the ability to apply more generous stress testing, CUs can potentially win younger customers, a segment that the sector has traditionally struggled to engage with. However, CUs will need to ensure they are able to reach these customers on their own terms – RFi Group data suggests that more millennials would prefer to apply for a mortgage through digital channels than via a branch, and CUs will need a strong digital presence if they hope to successfully attract these younger customers.
Overall, Canadian mortgage lenders may experience considerable challenges in 2018; much will hinge on how aggressively CUs and other non-banks court borrowers that do not meet the stricter stress testing criteria, and whether they can convince these borrowers to bring their other products with them if they do choose to borrow from a CU. If they can, the repercussions will be felt not just in the mortgage market, but across the entire banking industry.