Mortgage rules implemented over the past two years, along with rising interest rates, have worked to improve credit quality and reduce the number of highly indebted borrowers in the market.

That’s according to a Bank of Canada research paper released this week and co-authored by bank staffers Olga Bilyk and Maria teNyenhuis.

“The number of new highly indebted borrowers has fallen, and overall mortgage activity has slowed significantly,” the authors wrote. “Tighter policies around mortgage qualification and higher interest rates are having a direct effect on the quality and quantity of credit.”

The research found the share of new mortgages being obtained by highly indebted borrowers—those with loan-to-income (LTI) ratios above 450%—dropped sharply following the introduction of a stress test in October 2016 for high-ratio mortgages. High-ratio mortgages an LTI ratio above 450%  made up just 6% of total mortgages as of Q2 2018, down from 20% in Q4 2016, the report said.

Similarly, the share of low-ratio mortgages (those with more than 20% equity) with a loan-to-income ratio above 450% fell following the similar stress test for low-ratio mortgages that came into effect on January 1, 2018. They now account for 14% of mortgages as of Q2 2018, down from 20% a year earlier.

The report notes that mortgage policies alone aren’t the only factors at play.

“Higher interest rates are directly increasing the cost of mortgage borrowing and effectively making mortgage underwriting requirements stricter,” the bank says. “At the same time, house price dynamics have changed in some large markets, in part because of regional policy measures.”

In the Greater Toronto Area (GTA), for example, the share of highly indebted borrowers fell from a peak of 39% in Q4 2017 to 28% in Q2 2018 following the provincial government’s introduction of a foreign buyers tax in April 2017.

Where are the High-Risk Borrowers Going?

Many homebuyers who can no longer qualify based on the new stress tests are simply taking out smaller loans, the report notes.

“As fewer loans are given to highly indebted borrowers, a larger share of mortgages is now concentrated around LTI ratios between 250% and 450%,” the authors wrote. “Mortgages with an LTI just below 450% are still relatively risky and likely include borrowers obliged to take smaller loans than they would have obtained without a stress test. At the same time, the revised Guideline B-20 has not eliminated high-LTI loans altogether, since lenders can apply other criteria to extend such mortgages, including the applicant’s housing equity and financial assets.”

But there’s also no denying that many who can no longer secure the mortgage they need are turning to private lenders, who aren’t federally regulated and don’t fall under the stress test rules.

In the GTA, a full 20% of refinancing mortgage deals in Q2 went through private lenders—a 67% increase over two years, according to a report from Toronto brokerage Realosophy and Teranet.

Mortgage expert and RateSpy.com founder Rob McLister wrote this week that there’s not enough information to “definitely conclude” the BoC’s assertion that “the overall riskiness of new mortgages has therefore decreased.”

“Not unless you limit that statement to federally regulated lenders,” McLister wrote. “Clearly the mortgage stress test has shifted lending from transparent lenders (e.g., the Big 6 banks) to non-transparent lenders (e.g., private lenders).”