Canada’s financial regulator, the Office of the Superintendent of Financial Institutions (OSFI), is actively evaluating a significant shift in how Canadians qualify for mortgages. The agency is testing a loan-to-income (LTI) cap as a potential replacement or complement to the existing Minimum Qualifying Rate (MQR), commonly known as the mortgage stress test. This move could redefine borrowing limits and impact the housing market.
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Key Takeaways:
- OSFI is testing a loan-to-income (LTI) framework until at least January 2026.
- The LTI limit may replace or complement the current MQR stress test.
- A portfolio-level LTI cap (4.5 times income for new uninsured mortgages) is already in effect for federally regulated lenders.
- Industry experts have mixed views on the potential impact, citing possible effects on affordability, market activity, and lender flexibility.
Evaluating the Loan-to-Income Approach
OSFI first proposed exploring an income-based approach to mortgage qualification back in January 2023. While other accompanying proposals were later shelved, the agency committed to studying a switch from the MQR, which requires borrowers to qualify at 5.25% or 2% above their contract rate (whichever is higher), to an LTI approach directly tied to a borrower’s gross annual income.
As an initial step, OSFI implemented a portfolio-level LTI cap for federally regulated financial institutions, effective starting in the first fiscal quarter of 2025. This rule limits the percentage of new uninsured mortgages a lender can issue that exceed 4.5 times the borrower’s income. This cap is applied across the lender’s total new mortgage volume, not on individual loans, allowing some flexibility within the portfolio.
OSFI Superintendent Peter Routledge stated in October 2023 that the agency would test the LTI approach throughout the following year to ensure it functions as intended. He indicated that based on this testing, the LTI could become a “legitimate alternative or a legitimate complement” to the MQR, with a final decision expected after a full year of evaluation.
More recently, OSFI has provided further details, confirming that the evaluation of the LTI framework will continue until at least January 2026. A spokesperson, Cory Harding, confirmed that the decision to adopt LTI as a complement or replacement for the MQR will be based on what OSFI learns from this implementation phase. While both rules aim to mitigate mortgage lending risks, LTI limits are specifically intended to help contain overall residential mortgage credit risk at the institutional level.
Potential Implications for Buyers and the Market
Adopting an LTI-based lending standard would bring Canada more in line with practices in other countries, such as the United Kingdom, where mortgage borrowing is commonly capped around 4.5 times income.
Paul Grewal, co-founder and president of Highclere Capital, notes that Canada’s move towards LTI aligns with global trends focusing on income-based affordability over stress testing for interest rate fluctuations. However, he emphasizes that the long-term effects on financial stability and housing affordability are still uncertain.
Paul Grewal, co-founder of Highclere Capital, offering insights on OSFI's proposed mortgage rule changes
Grewal suggests that the switch could have contrasting outcomes. It might restrict buyers, potentially dampening home prices and encouraging purchases of smaller or more affordable properties, leading to greater economic stability. Conversely, it could potentially make it easier for some first-time homebuyers to enter the market, increasing demand and prices while leaving borrowers more vulnerable to interest rate increases.
Beyond the LTI change, Grewal advocates for broader housing policy reforms, citing models like Finland’s “Housing First” approach and recommending increased density, mixed-use developments, and prioritizing suburban housing construction over solely urban centres.
Joe Jacobs, Managing Partner at Mortgage Connection and past Chair of Mortgage Professionals Canada, believes the LTI switch might not cause dramatic long-term changes for most borrowers. However, he warns of potential short-term disruption, particularly if both the MQR and LTI rules were applied simultaneously during a transition phase.
Greater Impacts in the Margins
Jacobs suggests that most borrowers who qualify under the current MQR would likely also meet the proposed LTI restrictions in isolation. The primary concern arises if the regulations overlap or are layered.
Joe Jacobs, Managing Partner at Mortgage Connection, discussing potential impacts of OSFI's LTI proposal
He describes the potential layering of rules as excessive and potentially limiting. Jacobs’ main reservation is that an LTI cap could reduce lenders’ flexibility to work with borrowers in unique situations, such as those with larger down payments, who might traditionally qualify with higher debt ratios.
He also notes that LTI measurements could have a more significant impact than the stress test if interest rates were to fall significantly, as the stress test’s effect diminishes in a lower-rate environment.
A Different Test for a Different Rate Environment
Jacobs acknowledges that the MQR stress test served its purpose during a period of historically low interest rates, helping to prevent borrowers from over-leveraging before rates climbed. However, he questions its continued effectiveness in the current higher-rate environment.
The MQR, being tied directly to interest rates, might not be dynamic enough for today’s market reality, according to Jacobs. While it was effective when rates were near 1%, he argues it may not serve the same purpose when rates are closer to 4.5% or 5%. He suggests the current 2% buffer above the contract rate might be too aggressive in this environment.
Ideally, Jacobs proposes a mortgage qualification test that is dynamic enough to adapt to varying rate environments without being solely tied to income or overly rigid. He notes the difficulty in implementing such a nimble, non-blanket approach but highlights that industry calls have included removing or shrinking the stress test buffer when rates are at more normalized levels.
OSFI’s exploration of an LTI rule signals a potential evolution in Canada’s mortgage regulatory landscape. While the outcome and exact implementation remain under evaluation, the shift could introduce a different framework for assessing borrower risk and reshape accessibility and dynamics within the Canadian housing market.
