Some Canadian homebuyers hoping to qualify for the biggest mortgage they can get might have been disappointed by the decision this week to keep the stress test unchanged.
The Office of the Superintendent of Financial Institutions (OSFI) said in its annual review of the mortgage stress test Thursday that it’s not going to lower the bar that pushes Canadians to qualify at rates higher than their actual contract rate from a federally regulated lender.
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Mortgage stress test remains unchanged. What that means amid higher interest rates
But institutions regulated at the provincial level don’t have to put mortgage applicants through federal stress test, offering some Canadians a way around the bar set for uninsured products by OSFI or the matching standard for insured mortgages maintained by the Department of Finance.
What are alternative lenders, and could these institutions offer a viable path to homeownership while skirting the mortgage stress test?
Here’s what you need to know.
What’s an alternative lender?
An alternative lender typically refers to any institution in Canada that’s not a chartered bank. This includes private lenders as well as credit unions, which are regulated at the provincial level in Canada.
Michael Hatch, vice-president of government relations at the Canadian Credit Union Association (CCUA), which represents 210 such institutions in Canada, says they’re the “only real competition” to the Big Six banks in the financial sector.
The credit union space has indeed seen growth in the Canadian mortgage market as interest rates have risen this year.
Credit unions’ mortgage balances increased 4.1 per cent between March 31 and June 30, per CCUA data. That outpaces the 2.6 per cent growth in mortgage balances at the Big Six over that time, according to Reuters’ reporting earlier this fall.
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Despite the growing business for credit unions, Hatch does not credit the mortgage stress test with the popularity among consumers.
“Ever since the stress test came into being a number of years ago, there’s been predictions that it would cause some sort of flood to non-federally regulated lenders, such as credit unions, which are primarily provincially regulated,” Hatch says. “And it just hasn’t happened.”
High rates make stress test more imposing
The stress test was introduced for insured mortgages in 2016 and for uninsured products in 2018.
There’s been minimal variability in the proportion of outstanding mortgage loans between banks and alternative lenders since that time, with chartered banks typically holding around 80 per cent of the market share.
According to the Canada Mortgage and Housing Corp.’s (CMHC) statistics for the second quarter of 2022, credit unions held 13.3 per cent of total mortgage loan values outstanding, with major banks holding just above the 80-per-cent mark. Private lenders and insurance companies accounted for the rest.
However, the Bank of Canada’s interest rates have been relatively low while the stress test was active. The current bar of 4.25 per cent for the benchmark interest rate is the highest since 2008.
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The stress test requires consumers to qualify at 5.25 per cent or their contract rate plus two percentage points, whichever is higher. For much of the pandemic, when interest rates were at historic lows, most applicants were qualifying for mortgages at the 5.25 per cent mark.
With the central bank’s latest 50-basis-point interest rate hike on Dec. 7, the Big Six raised their prime lending rates in concert to 6.45 per cent. That means some Canadians are having to qualify at rates higher than eight per cent for their mortgage today.
Higher rates, shorter terms typical with alternative lenders
Leah Zlatkin, mortgage broker and expert with LowestRates.ca, tells Global News that it’s worth shopping around for different rates to see if an alternative lender can get you more bang for your buck. She cautions, however, that there are nuances to the alternative mortgage market that a homebuyer ought to keep in mind.
“Every lender is a little bit different, but there are absolutely options out there for people who want to try and qualify for more,” she tells Global News. “You just need to be very cautious in evaluating all of your options.”
Oftentimes, the trade-off for getting a larger mortgage amount from a private or alternative lender comes at a higher rate on your mortgage, Zlatkin says.
Terms also tend to be shorter, with the possibility you’ll have to go through the laborious process of renewing every year, she says.
In the case of some credit unions, Zlatkin says you also might need to pay a regular fee to remain a member. These should be added into your monthly costs when you’re doing calculations for the length of your mortgage, she says.
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Hatch says that credit unions are not just the plan B that Canadians turn to when they can’t qualify for the mortgage they want at a chartered bank.
Credit unions have been able to grow their business in an environment of high inflation and rising interest rates because they are able to offer competitive products compared to much larger lenders, he argues.
“We compete on price and on every other metric that we have to compete with massive institutions that dwarf us in terms of size,” Hatch says.
However, the smaller footprint is a selling point for credit unions, according to Hatch. Credit union membership, which is usually a requirement to receive a loan, can offer profit-sharing benefits in the same way shareholders can own traditional banks.
Who should seek out an alternative lender?
Zlatkin says alternative lenders are often the right fit for mortgage applicants that have unusual circumstances or difficulty proving income sources.
The self-employed or those receiving regular disability payments are a few instances where an alternative lender could better validate your ability to pay down a mortgage, she says.
While alternative lenders such as credit unions can be pathways for some struggling to get a mortgage, Hatch says the lack of a stress test does not mean due diligence isn’t applied to a loan.
Credit unions follow the regulations set out in their home provinces, he notes, which will include their own stringent guidelines for underwriting a mortgage.
“Credit unions are in the business of lending money, of course, but primarily they’re in the business of not saddling their members with debts that they can’t afford,” Hatch says.
Zlatkin says that some mortgage brokers will help their clients access a high-rate mortgage from a private lender and then move them up the chain towards a low rate with a chartered bank once their credit is repaired or their income levels have improved.
That doesn’t mean, however, that everyone should jump into the market just because they can, she adds.
Though she admits she’s biased by her position, Zlatkin says working with a broker or a mortgage professional that understands your unique financial situation should be the first step before taking on a loan, whether from a major bank or alternative lender.
While the stress test can be frustrating for some buyers desperate to get into the market, she also notes it can be a valuable gauge as to whether you ought to wait to get into the market or jump in with as big a mortgage as you can afford today.
A good mortgage broker has access to all lenders’ products and can show you what you can realistically afford, whether you pass a stress test or not, Zlatkin says.
“Everybody feels like the stress test is penalizing people. It’s not penalizing people. It’s making sure that they have the stability and the wherewithal and the finances to be able to continue living in their home once they buy it,” she says.
“You don’t want to help somebody bite off more than they can chew.”
— with files from Reuters