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How credit unions offer homebuyers a way around mortgage stress tests

Provincially regulated credit unions aren’t bound by OSFI’s mortgage stress test and homeowners have taken notice

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There’s a multi-million-dollar corner of Canada’s financial system where a stringent “stress test” imposed by the Office of the Superintendent of Financial Services was never adopted. It’s already attracting homeowners seeking an easier path to qualify for a mortgage amid rising interest rates and it’s poised to grow further as the spectre of even tougher mortgage qualification rules threaten to push bank loans out of reach for homebuyers.

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Provincially regulated credit unions such as Meridian and DUCA are not bound by federal rules, and can choose whether or not to apply OSFI’s strictest qualifying standards for uninsured mortgages, subject to any rules adopted by their provincial regulators. 

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While the credit union sector has chosen not to widely promote so-called “contract-rate qualification” mortgages — where borrowers are assessed based on actual interest rate they will pay rather than OSFI’s stress test — figures released by Canadian Credit Union Association show the lenders have been steadily picking up business, growing their mortgage books by 4.1 per cent in the second quarter and two per cent in the third quarter of 2022.

Rob McLister, a mortgage analyst and strategist, estimates that hundreds of millions of dollars’ worth of mortgages have been underwritten using contract-rate qualification.

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“Speaking with (executives) at some of these credit unions, the message is that they’ve seen considerable growth in products like contract-rate qualification mortgages,” McLister said. “But that growth is coming off a small base because it’s a small market to begin with.”

Whether the credit unions decide to press their advantage, especially if additional measures tighten lending standards for the banks, remains to be seen.

Those new measures, proposed by the federal banking regulator in January in a consultation aimed at addressing the impact of rising rates on households already steeped in debt, could add even more onerous loan-to-income and debt-service coverage restrictions to the existing stress test. Since 2018, OSFI rules have pegged the qualifying rate for an uninsured mortgage at the greater of the contract rate plus two per cent, or 5.25 per cent.

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Bank and office towers in Toronto's financial district.
Bank and office towers in Toronto’s financial district. Photo by Peter J. Thompson/National Post

Any of the individual proposed additional measures would limit buying power for would-be homeowners, said McLister, who suggested some borrowers “will most definitely gravitate to credit unions that don’t adopt OSFI’s guidelines.”

Most credit unions in Canada are regulated in a distinct provincial and territorial system parallel to Canada’s big banks. There is much alignment, but also regional differences including the amount of deposit insurance on chequing and savings accounts. In 2012, the federal government paved the way for credit unions to expand beyond provincial borders to become federal financial institutions, but there was very little uptake.

Some credit unions and their regulators have mirrored OSFI’s most stringent mortgage qualification standards to date. However, others such as Meridian, the country’s second-largest credit union, still offer a contract-rate qualification mortgage with terms that were in place before OSFI updated its stress test in 2018.

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“We offer contract-rate qualification mortgages in some instances,” said Teresa Pagnutti, senior manager of public relations at the St. Catharines, Ont.-based Meridian.

Like all the credit union’s lending programs, such loans are extended based on a “holistic and prudent review” including assessing a customer’s cash flow and borrowing capacity, she added.

Meridian offers contract-rate qualification mortgages.
Meridian offers contract-rate qualification mortgages. Photo by Peter J. Thompson/National Post

Meridian tells prospective buyers on its website that, as a credit union, it is “more flexible than banks when it comes to approving mortgages” and can help those who wouldn’t pass the federal stress test buy their dream homes by taking “income appreciation” and accelerated payment options into account.

Last year’s gains in mortgage volumes in the credit union segment of the market came as interest rates began to rise following an extended period of ultra-low rates.

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The Bank of Canada announced three hikes to its key overnight rate in the second quarter of 2022, lifting it to 1.5 per cent before a monster 100-basis-point increase in July. By the end of the year, rates had climbed further, reaching 4.25 per cent, and the central bank announced another 25-basis-point hike on Jan. 25, 2023.

The credit unions’ gains were achieved even as the number of homes bought and sold was falling. Transactions in July, for example, came in 29.3 per cent below activity in July 2021, according to the Canadian Real Estate Association (CREA). Sales were down in roughly three-quarters of all local markets, led by large cities and their surrounding areas including Toronto, Vancouver and Calgary.

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For those struggling to afford a home with interest rates well above where they sat for many years — even as house prices cool — going the route of a contract-rate qualification mortgage could be appealing.

Credit unions have added new mortgage customers even as the number of homes bought and sold fell.
Credit unions have added new mortgage customers even as the number of homes bought and sold fell. Photo by Paul Morden/The Observer

McLister said the contract-rate qualification formula alone gives a borrower between five and 11 per cent more buying power, depending on the lender and term and assuming a 30-year amortization.

His ballpark estimate that the size of the market is in the hundreds of millions of dollars, which he called “conservative,” is based on total annual mortgage originations at credit unions and the percentage of volume coming from contract-rate qualification mortgages, as extrapolated from data at a sample of credit unions. Though it’s a considerable amount of money, he noted that it represents a small corner of the roughly $450 billion in new mortgages underwritten each year.

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Still, it’s a segment of the market that has drawn the attention of analysts at credit rating agency DBRS Morningstar. In a Jan. 10 report, they highlighted the differences at credit unions across Canada when it comes to adoption of OSFI’s strict mortgage underwriting guidelines.

DBRS noted that while most credit unions have underwriting practices that “emulate the spirit” of OSFI’s original stress test from 2012, some of them — notably in British Columbia and Ontario — have not updated the more “rigorous” test adopted in 2018.

Provincial regulators in Alberta and Saskatchewan, on the other hand, did follow the more rigorous test in OSFI’s guideline B-20 for credit unions in those provinces, a stance the DBRS analysts said they viewed “positively.”

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Russ Courtney, a senior media relations officer at the Financial Services Regulatory Authority of Ontario, which regulates credit unions in Canada’s largest province, said the act that governs the member-owned financial co-operatives does not require prescriptive interest rate stress testing in residential mortgage underwriting. Instead, credit unions can determine the type of stress testing that is most appropriate for their individual mortgages and mortgage portfolios.

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“As such, each institution has its own approach, reflecting what is most appropriate for the characteristics of their residential mortgage business,” Courtney said, adding that FSRA closely monitors and assesses the activity and risk profiles of credit unions and performs its own internal stress tests on credit union mortgage portfolios.

He said the provincial regulator has not seen what it considers to be a “material” increase in the volume of residential mortgage business activity or in the risk profile of Ontario credit unions.

One reason for the muted uptake might be that, as the DBRS report noted, even credit unions that do not use OSFI’s strictest qualifying standard as a general rule must do so for some home loans if they hope to use mortgage securitizations as a source of funding available through programs available through the Canada Mortgage and Housing Corporation (CMHC).

Another factor that could be keeping a lid on the shift to credit unions is that few broker-channel lenders offer mortgages underwritten at the qualifying rate and the public is largely unaware they exist, according to McLister.

“Only a small percentage (of credit unions that offer them) promote contract-rate qualifying publicly or to third parties” such as brokers, McLister said.

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