OSFI report reveals largely unknown mortgage exemption: no stress test on insured switches
Many in the mortgage industry reacted with surprise after learning about a little but very important nugget buried in an OSFI report released earlier this week.
In its report on industry feedback concerning its proposed underwriting changes to B-20, Canada’s banking regulator said this:
“Insured borrowers…are exempt from the re-application of the MQR (Minimum Qualifying Rate) when switching lenders at renewal. This is because the borrower’s credit risk has been transferred for the life of the loan to the mortgage insurer.”
The revelation caught many mortgage professionals off guard. Based on current lending practices, it had been widely presumed that the mortgage stress test on transactionally insured mortgages (borrower-paid), which falls under the purview of the Department of Finance, was federally mandated for both purchases and mortgage switches.
In a statement to CMT, default-mortgage insurer CMHC confirmed the practice.
“It has been a long-standing policy to allow the transfer of a CMHC-insured loan from one Approved Lender to another subject to certain terms and conditions, which include the requirement that the loan is not increased and continues to amortize in accordance with the amortization period approved by CMHC,” the agency said.
It’s important to note that even though the Department of Finance doesn’t require insured switches to be re-qualified under its mortgage stress test, lenders may still choose to do so at their own discretion.
“It is expected that an Approved Lender complete due diligence reviews when accepting the transfer of CMHC-insured loans, as in so doing they assume all responsibilities of the original Approved Lender,” CMHC added.
What is the mortgage stress test? The mortgage stress test for default-insured mortgages (those with a down payment of less than 20%), was introduced by the Department of Finance in 2016. Similar to the stress test for uninsured mortgages, which is overseen by OSFI, borrowers must qualify at the higher of the MQR (currently 5.25%), or two percentage points above their contract rate, whichever is higher. In today’s high rate environment, practically all mortgages are being qualified at the latter.
What is a mortgage switch? A mortgage switch is the process of a borrower taking their existing mortgage from one lender to another, either at or prior to renewal.
“We recognize that this may be new information to some brokers and lenders,” Lauren van den Berg, President and CEO of Mortgage Professionals Canada, told CMT. “However, this does not mean that lenders will not conduct their own prudential risk assessment, such as employment or income verification, to mitigate against any fraud or misrepresentation.”
Tyler Hildebrand, a mortgage broker with Saskatchewan-based oneSt. Mortgage, said he was excited to learn about the exemption, particularly since he believes it will lead to more choice for borrowers and should “open up the competitive landscape” for the vast majority of his high-ratio clients.
“There’s no question that a certain percentage of borrowers had the impression that they had no choice but to accept a less-than-attractive offer from their existing lender,” he said.
For OSFI’s part, while uninsured mortgage switches still face re-qualification under its own stress test, the regulator says it will “continue to monitor for evidence of uncompetitive rates for borrowers who may be unable to switch lenders, and we will take action if warranted.”
More insured switches are likely to take place, some say
Now that this exemption is becoming widely known, expect to see more lenders stepping in to offer these kinds of deals and brokers offering switches as an option to their insured mortgage clients, some say.
“Small lenders are likely to step up and offer it,” Ron Butler of Butler Mortgage told CMT.
Hildebrand agrees that they’re about to become more prevalent.
“I imagine in short order the entire landscape will adopt the policy pretty quickly,” he said, adding that will be a good thing for borrowers.
“Increased consumer choice, especially in a rising rate environment, will protect a lot of borrowers from a ‘take it or leave it’ type scenario,” he noted. “That said, I don’t believe this will have a material, or really any impact on market rates.”
Sources told CMT that just two lenders, Radius Financial and THINK Financial, were aware of the exemption prior to this week and had already been doing insured mortgage switch deals.
Dan Eisner, founder of THINK Financial, told CMT the news that insured switches aren’t federally mandated to be re-qualified under the stress-test is a bit of a “red herring.”
“Just because the insurer doesn’t require a new stress test doesn’t mean the lender doesn’t,” he said.
Asked when he first became aware of the exemption in the federal regulation, Eisner said “it was always a fact.”
“These were always the rules. The government didn’t hide anything here,” he said. Eisner added that the volume for these kinds of deals is “very small,” and that he doesn’t expect many lenders will rush to offer them.
Switches still require thorough underwriting
While many in the industry are learning that insured switches don’t need to be qualified under the mortgage stress test, Canada’s national association representing mortgage professionals made clear that default-insured mortgage switches still face rigorous underwriting standards.
“As is well known, lenders are required to immediately report to the mortgage insurers if false or misleading information has been provided or is suspected in an insured mortgage application,” MPC’s van den Berg noted. “If a lender does not do an appropriate risk assessment and misrepresentation is found, any insurance claim may be null and void leaving them responsible.”
Hildebrand echoed the stringent due diligence that takes place for such deals.
“On a switch to a new lender, the file receives full underwriting, including an evaluation of LTV and verification of income,” he said. “There is no situation where a lender or investor would onboard risk without properly assessing said risk.“